Excesses of state and markets

The economy has slowed down; the rupee has dropped to its lowest value. After years of continuous growth, exports too have declined. Stocks have tumbled. Moody's has downgraded India's great institutions like the LIC, the State Bank of India, ICICI and HDFC. Inflation too persists.

Professor Michael Sandel, the Harvard Guru whose fascinating lectures appear on TV on Sunday morning's starts his book Justice : What is the right thing to do, with the story of “price gouging” as an aftermath of the Florida cyclone: An elderly woman with an aged husband and handicapped daughter had to flee her home; she was charged four times the normal rate in a motel. Likewise, the price of ice went up five times; that of small household generators went up eight times. Trees fell on houses. A builder charged $23,000 to clear the trees.

Professor Sandel asks “Is that right?” He then quotes Professor Thomas Sowell who said that there was nothing wrong; people get accustomed to a price, but there is nothing sacred about it. Sowell has a point. In India, bus fares are ten times lower than they are in the US, but car prices are cheaper in the US than they are in India. Which then is the right price?

Price gouging generally occurs at times of acute shortage. At those times, what can businessmen do? Can they ration sales? If they want to do so, can they sustain it? Is it not best for them to ration the short supply by raising prices? Initially, the rich benefit and so does the trader; the poor suffer. However, the problem is temporary. With higher prices, supplies will rush in and a new stable price will result. No doubt there is a glitch but it is curable.

The alternative is for the government to do the rationing. Unfortunately, that does not work very well. Rationing leads to corruption. A new business starts off making money by getting round the rules.

Those corrupt officials will not give up that opportunity to make hidden profits easily. Hence, government rationing tends to last far longer than price gouging; it is not self-correcting.

NOT BY RATIONING

Years ago, I told Professor Madhu Dandavate, then Minister of Railways, of the harm done by rent control in the city of Bombay. At that time, it was estimated that around a hundred thousand flats were locked up by their owners because — once rented — they had little chance of getting their property back. If only the controls were removed, those flats would have entered the market, thereby, reducing rents.

What is more, a hundred thousand less attractive flats would also enter the market and the process would go on until a hundred thousand families currently living on pavements would have moved to better residences. He did not refute my argument, but as a socialist he would not do anything about it.

Professor Sandel gives also the other side of the argument in favour of price control. He quotes Crist, then Attorney General of Florida: “This is not the free market situation where willing buyers freely enter into the marketplace and meet willing sellers, where a price is agreed upon based on supply and demand.” In short, there is not enough competition.

Then, it appears that the government's responsibility is to ensure enough competition. The Florida case was an emergency. The government could have, and should have, rushed required goods from the rest of the country, at low or even zero cost, to tide over the emergency. On the other hand, ours is a chronic problem. We need a change in our system of governance.

BANK CREDIT

First, let us accept that interest on money generates unearned income. You and I have surplus of income over current expenses but do not know how to exploit that surplus for profit. So, we give our surplus to those who can make use of it and, sitting at home and doing nothing, earn interest. The higher the interest, the higher is that unearned income. Thus, at best, interest rates ought to be as low as possible.

Unfortunately, businesspersons tend to be greedy. They are liable to take our money and spend it on supplying luxuries at high profit rather than on supplying necessities at low profit. Hence, interest rates should be low only for the production and supply of necessities, and not for luxury goods. Unfortunately, money is fungible; it tends to leak.

Looking at the situation from another angle, pure markets tend also to increase the disparity between the rich and the poor, between rich regions and poor ones ( Businessline , May 15, 2012). For that reason, the interest rates deserve to be lower in poor places and higher in rich ones. Thus, the Reserve Bank should have variable rates — high ones in cities and rich States and low ones for smaller towns and poor States. Some leakage will occur but should be manageable.

The Reserve Bank could also give preferential rates for necessary services only — such as food storage, schools, healthcare, water and sanitation. Housing is a different proposition. It is a necessity both for the rich and for the poor.

Hence, no distinction should be made whether housing is for the rich or the poor provided two conditions are satisfied: One, Floor Area Ratio is not higher than 0.5 (the figure New Delhi used to have at the time of Independence). Two, observe the Pareto criterion: 20 per cent of the space should be reserved for the bottom 50 per cent of houses.

The first criterion is enough to ensure that low interest rates will be available in small locations only; the second will ensure that the poor get their due share.

This is 329th in the Vision 2020 series. The previous article appeared on May 5.

(The author is a former Director, IIT, Madras. Responses to indiresan@gmail.com and blfeedback@thehindu.co.in )

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