T N Ninan: A strange idea

WEEKEND RUMINATIONS

The lesson of the past week, indeed the past many weeks, is contained in the old wisecrack about India: that it is very good at running states and markets; the only problem is that it runs states like markets, and markets like states. It is still to learn the basic rules about how to run markets like markets.

When producers are strong-armed into reducing prices, when futures trading gets banned, when banks are told not to respond commercially to the actions of the monetary authority, and when the door is opened or shut to export markets seemingly at whim, then we have not learnt a basic rule of economic administration: do not look for administrative solutions to economic problems, look for economic solutions.

The problem with administrative responses to economic problems is not just that they don't work except in an immediate, short-term context (remember that politically-ordered free power for farmers has caused permanent power shortages in India); it is that they start affecting the economic responses of all the non-state actors. What is the impact of the decision in 2006 to ban sugar exports? Do we know how much it has affected the confidence level of sugar producers in setting up the production capacities with which they can become world-beaters? What if they set up the capacity and then cannot export because of a government order? That same question will be asked by the producers of milk powder, who know that their impact on liquid milk prices is marginal, but who were prevented nevertheless from serving overseas customers three months ago""and India might not become a dairy power, as a consequence. Cement and steel producers, to take the prime examples of the past week, have suffered poor margins for years; indeed, abnormally low steel prices were the largest cause of bank defaults a decade ago. They will now wonder why they have to suffer the downside of the business cycle, but not enjoy the upside""and whether it is worth setting up new capacity if those are going to be the rules.

Administrative responses to economic signals (like prices) invariably involve making a choice between producers and consumers. The paradox is that when it comes to agricultural products like onions and wheat, the politician plumps for the consumer every time, and forgets the interests of suicide-prone farmers. But when it comes to industrial products, the producer has often got the better side of the bargain in that the government used to be ever ready to restrict competition. I use the past tense here because the awareness is now greater that competition helps consumers and producers as well, over time. In agricultural products, however, the politician wants low prices for consumers, and high prices for farmers. He has not figured out how to get both, because he does not introduce the third and fourth variables: time (low or high prices today, or over a sustained period?); and the trade variable. The system frowns on organised retailers who might do better than today's inefficient distribution chain, which gives us retail prices that are typically 3.5 times farm-gate prices.

The administrative virus breaks out in all manner of boils. The rules that govern labour markets have created a permanent shortage of organised sector jobs, for instance (the organised sector accounts for only 7.5 per cent of all jobs, and only 2.5 per cent is in the private sector). The administrative rules on real estate have likewise created some of the world's highest prices for land""when the majority in our cities happen to be homeless. One can go on, but what is astonishing is how the politician does not see the pattern and views each economic problem as one that he has to fix there and then, by executive fiat.

The lesson of the past week, and of the past few months, is that even 16 years after economic reforms began, the idea of (and the virtue in) allowing markets to function is a notion that is fundamentally alien to the political class.