The Hindu Business Line : Making goods affordable for poor

In India, many people are so poor that they cannot enjoy many services unless they get it free. The ideal way of giving the poor what they need at a price they can afford is to convert that need into a public good, and make the facility or product available through capital-intensive production, says P. V. INDIRESAN.

In the previous article, I pointed out that because the Public Distribution System in India is vitiated by waste, inefficiency and corruption, food distribution could improve if the PDS was replaced by a competitive market.

That suggestion has been criticised on the ground that the market is not geared to cater to the poor. Many people oppose the market mechanism even though poverty is generally less in market economies than in government-controlled socialist ones. Here is an issue that deserves further discussion.

Basically, there are two ways of giving the poor what they need at a price they can afford. One — the ideal one — is to convert that need into a public good. The second method is to add frills and luxuries to a basic need, sell it to the rich at profit, and use that profit to subsidise the poor, who then get the essential part of the service at an affordable price or even free.

Viable examples

The street-light is a good example of a public good. It shines on the poor beggar with the same intensity as on a rich tycoon walking to his BMW; it makes no discrimination between the rich and the poor. The second option of cross-subsidy has been successfully used in hospitals, schools and in public transport too. The best example of cross-subsidy is the way Lord Venkateshwara gives darshan in Tirupati: It is absolutely free for those who cannot pay, for anyone who does not want to pay. It is worth noting that in His case, no attempt is made to check whether those who demand free darshan are truly poor or not.

It is left to the individual’s choice whether to pay and stand in a shorter queue, or stand in a longer one to get the same service free of charge. By leaving the decision to the customer, the Tirupati temple has saved itself considerable headache, and avoided corruption too.

In India, many people are so poor that they will not be able to enjoy many services unless they get it free. So, a free component of service is important. It is equally important that, in essentials, the service should be no different for the poor compared to the rich. It would not do for the Tirupati temple to show the poor a pseudo idol, reserving the genuine one for the rich donor.

Government schools are free but, in a number of cases, there is next to no instruction. The service may be free but quality is not genuine. Hence, there are two conditions to be satisfied in catering to the poor. One, the price must be low enough to be affordable; ideally, it should be free. Two, even if there are no frills, the essentials should be held sacred.

Marginal cost

As shown in the Diagram, the supply curve tends to go flat for a public good; it costs nothing extra to add one more customer. In economic jargon, the marginal cost (Curve A) of a public good tends to zero. Scarce goods are the opposite: Their marginal cost tends to increase for each addition to supply (Curve B’). Real-estate is a classical example of scarce good; the slightest increase in demand raises costs sky-high.

Computer chips are a good example of marginal prices being much less than the average: If it costs a million rupees each to produce the first thousand units, it may cost only a thousand rupees to produce the next million, and only hundred rupees thereafter.

In such a case, the first million may be sold for thousand rupees and thereafter, the same chip may be sold for two hundred rupees, and yet yield profit. In fact, the best time to buy any computer product is tomorrow.

Then, the poor may be sold last year’s fashion (but a usable one) at bargain prices. The same thing can be done, is done, for perishable commodities.

Aeroplane seats and hotel rooms are examples of perishable products. An airline seat or a hotel room left unfilled is a loss forever. Hence, it is worthwhile for an airline to sell seats that would otherwise go empty at throwaway prices. Often, the person sitting next to you in an airline would have paid a fraction of what you paid.

Capital-intensive

In either case, whether it is a computer chip or an airline seat, the supply is capital-intensive. Strange as it may appear, the best way to help the poor is to resort to capital-intensive production.

In that case, we may meet the (heavy) fixed costs from public funds and charge the customer only the much smaller marginal costs. That is how the Delhi Metro operates. If the Metro were to charge the full costs, even the well-to-do would not be able to afford it.

One might well ask if basic goods are made capital-intensive, how the poor will ever find jobs. They will do so when luxury goods are made labour-intensive. For example, the poor may be given prefabricated shelter even as the rich get elaborately fashioned custom-designed houses. The rich may stay in private wards with many attendants while the poor get dormitories. In brief, the following rules apply:

In a free market, sale price tends to follow marginal cost.

In capital-intensive production, fixed costs are high; marginal costs tend to decrease.

Therefore, the poor get a chance to buy when the production is capital-intensive — provided there are no physical limits to supply.

The opposite is true: The poor will not afford the prices when production is labour-intensive.

It is best to combine capital-intensive production with cross-subsidy from the rich (who pamper themselves with frills of luxury), and further, meet fixed costs from tax revenues.

It is important to note that marginal costs decrease only when there are no physical limits to supply. Real-estate is a classic case of limited, scarce supply. Hence, it would appear that this proposition — capital-intensive production will help the poor — will not apply in the case of shelter. Actually, in this case, ours is a bad government. It keeps real-estate in short supply artificially to help the powerful make pots of money. Shelter is a case of deliberate denial of a basic need to the poor.

There is enough land and more in India for everyone, including the very poor, to have large enough roofs over their heads if only available space is better allocated. That is self-evident in villages; that is true for cities too. After all, many countries with higher population densities than ours house their people satisfactorily; they have no slums, and no poor without roofs in villages either.

(To be continued)

This is 209th in the Vision 2020 series. The previous article appeared on September 3.

(The author is former Director IIT, Madras. Response can be sent to indiresan@gmail.com)