The Reform Train finally saw the Green light!

So, Prime Minister Manmohan Singh finally signaled the ‘green light’ to the reforms train. What made him to go after the so-called ‘big bang reforms’? Did he respond to the most scathing attack by a Washington Post columnist  Simon Denyer (referring him as a ‘tragic’ figure) or the economy continuously going down and down to such an extent that it warranted threating to downgrade India’s rating status by the dubious global rating agencies and Planning Commission’s reduced economic growth forecast to 8.2% for the 12^th five-year plan. Well, my haunch is that he responded more to the sharp comments made by Simon Denyer than the economy moving to the ‘twilight zone’. After all it is learnt that Prime Minister said in a cabinet meeting that “if we have to go down, we have to go down fighting”. Expectedly this brings cheers to “deficit hawks”!

Well, will the incremental reforms see the light of the day? It depends. It depends upon a combination of factors: the commitment of the respective ministers to get it implemented, administrative reforms and writing down the rule of law very clearly and so on. It is a well-known fact that growth economists around the world want the countries to have a good legal framework that would play a crucial role in wooing investment. Writing down clear “rule of law” would protect the investors’ interest, their property rights that allow investors to appropriate their fair share. Now we shall discuss the reforms one by one.

Diesel prices

The diesel price has been increased by Rs 5 per liter. And the number of LPG cylinders that a consumer can access in a year has been slashed from 17 to 6. Does it merit increasing the price? No. Well, the advocates of reform camp would argue that it was a much needed step to rescue the bleeding oil marketing companies (OMC) and reigning in the cancerous growth of the fiscal deficit.  But if I were to argue my line of reasoning would be different from the prevalent understanding. A high oil price has these following merits. First, investments on alternative energy sources would rise. Global warming is one of the biggest challenges the world is facing today. We know that temperature is going up and up. Transport sector is a significant contributor to the global warming  via CO2 emission. Hence, it merits allowing price to rise. It is a sort of carbon tax or Pigouvian Tax.  It would lead investment on alternative energy sources. In 2007, Phill Izzo has to say this. 

The government should encourage development of alternatives to fossil fuels, economists said in a WSJ.com survey. But most say the best way to do that isn't in President Bush's energy proposals: a new tax on fossil fuels. (See Wall Street Journal: Is It time for a New Tax on Energy?, 2007).  

Similarly, Harvard economist Greg Mankiw also advocated for Pigovian taxes, for it has tremendous merits. In this way, it may lead towards achieving ‘energy independence’. Second, we know that traffic problem has emerged as a biggest obstacle to cities in India. It would force commuters to use the mass rapid transit system. Third, it would accrue to benefit to India. We know that we import around 80% of oil.  This puts a heavy burden on the current account. Having said this, it must not be taken granted that India should shoulder all the responsibility in reducing carbon emissions from the world. Well, all sound good! But the million dollar question is does India need this price hike?

But the notion of ‘loss’ is highly questionable. Economists C. P. Chandrasekhar and Jayati Ghosh in a Macroscan column rightly questioned the rationale of India imposing 43% of tax in petrol price (and 32% for diesel). See the below charts (which are taken from Macroscan). In fact, this is a fake subsidy that the Singh government is vigorously pursuing to reduce it.

The last Chart, in fact, shows that the fuel tax collection outnumber the fuel tax subsidies. See Surya Sethi’s article published in the Economic and Political Weekly where he analyzed in detail recommendations of The Parikh Committee on pricing of petroleum products and expose the fallacy of subsidy. When developed countries like the US, Canada, Japan have low tax rates on gasoline products, what explains such a high tax rate in India? Then why this madness?

Similarly, the government also announced that it would reduce number of subsidized LPG cylinders a household can avail in a year. Though data on various taxes imposed on LPG is not available, I believe it is the same case for LPG cylinders. On the whole my argument is that government should not have hiked the prices. The current price already has taken care of Pigovian taxes.

FDI in Retail

To revive the market ‘sentiment’ or ‘confidence’ of investors, it has also opened up its $500 billion retail market and aviation sector to foreign participants. Notwithstanding the opposition’s opposition it merits to allow FDI. Note that the same BJP has even permitted 100% in retail in 2001 (see the OP-ED on the Indian Express published on 22^nd September, 2012). Surely, it would bring modern technology, management that would help save one-third of our produce getting rotten. Also it will help reduce food inflation. consumers would benefit. Farmers too. Remember in 1991 we too debated. That time, off course, was different. We didn’t have experience of the benefits of reform. Hence, at that time our apprehensions deserved merit. But does it merit even now, after seeing and enjoying the benefits of those reforms for 20 years? If yes, then what have we learned? Remember foreign retailers would be allowed only to cities having population one million. We did not we make noise when domestic organized retailers come to exist. How many small shops have been eliminated after the arrival of Big Bazar, Reliance Fresh, and Shopper’s Stop? Then why now? Is it because it is foreign capital?

Well, we are told that a crisis-hit economy requires foreign capital. It has to be evaluated with respect to these four factors: ‘net’ employment, food price, supply management and value chain, and volume of foreign capital. A NCAER study finds out that it is a win-win situation for all the concerned stakeholders. But nobody has said how much capital it would bring to India. I think we should do it as a case study like this. First, count the current retail employment in Delhi. Then after 4-5 years of organized retail, we should again see the retain employment. Then we can say what happens to ‘net’ employment.

One point I want to discuss here with respect to its impact on employment. I want to invoke here David Laibson’s “pull of instant gratification” theory to argue that it may lead to create employment. This is one of the theories of consumption function. In a nutshell this theory says humans like to have what they want right now, not later. They are impatient. It means people have self-control problems. Pulled by psychology we do things instantly to satisfy our pleasure or happiness in a way that we ourselves don’t appreciate in the long run. In plain English, we consume more than what we initially planned to consume and beyond our requirement.  Off course, implicit assumption of this theory is that consumers have access to money. To give an example, we plan to purchase one or two things and fix our budget, say Rs 500. And we plan to buy it from a departmental store or supermarket. But when we reach there and see so many things in front of our eyes, we lose self-control and forget that we fixed our budget to Rs 500. Especially, when we see the “discounts”, “offers”, our ‘instant gratification’ psychology compels us to purchase that thing. In the end, we end up purchasing a lot of stuffs and budget well going over Rs 1000 or more (well, strictly greater than Rs 500). I personally know some of my friends who kind of request me not to invite them when I go to Big Bazar, for the fear that though they don’t have anything to purchase but they will buy something significantly. If this is true, then my haunch is that it would also create employment. If we purchase more then surely they would produce more and hence, employ more people. Looks convincing?

 Questions, however, do need to be asked. How much capital would come to India? Most importantly, by allowing FDI to retail sectors government thinks that it can solve all our supply side problems like setting up of cold storage, go-downs, and so on. The government perception that it would be messiah is ridiculous. Does it mean that the government washes off its hand of all the responsibilities of supply side management of agricultural produce? But Wal-Mart, Carrefour, Spencer, and Metro would not go to villages to establish cold-storages. How much of our produce would be stored in cold-storages? What percentages of our wastage and rotten produce they can save? I guess we have no answers. Hence, government should not forget its responsibility of creating infrastructure in agricultural produce management.

FDI in Aviation

I think opening up this sector to 49% for the foreign participants serves well for the ailing aviation industry, both private and public. Especially, if Indian Airlines agrees to sell some of its stake to a foreign participant, it would save the taxpayer’s money. See the arguments here, here. It would infuse capital, management technique to the industry. Both passengers, aviation industry will benefit from it.

Do I oppose reforms? No. In fact, this price hike was not warranted.  I welcome reforms that would surely revolutionize in its impact on the performance of that sector. Why don’t you reduce various indirect taxes on oil products? Nobody answers this. Everybody hails this as if it is the biggest reform after independence!

A comment on the Prime Minister’s Speech

I sincerely thank you for explaining the rationale of recent economic policy decisions to the aam admi for whom you seem to be very concerned. In fact, you could have explained it much before. In your speech, as usual, you invoked your patented statement ‘money does not grow on trees’. Surely Not. O.K. Coming to your reason of hiking diesel price you told us that it warranted a Rs 17 per liter hike but your benign government only allowed a rise of Rs 5. You produced some dry figures. You even told us that your government reduced taxes on petrol by Rs. 5 per litre to prevent a rise in petrol prices. Why don’t you do this for diesel? Why did not you tell us the merit of imposing such high taxes on oil products? You did not tell that it is a fake subsidy that your government is trying to reduce. 

You said that SUVs (Sports Utility Vehicles) are the biggest beneficiary of these subsidized diesel price and hence, you want to tax them. Surely, government should not run large fiscal deficits to subsidise them. If this is the objective, this can be achieved in other ways. If you are really concerned, then you should impose tax on SUVs.  Why should everybody be punished for few SUV owners and few diesel car manufacturers? You won’t do that. Because it would hurt the interest of capitalists, for whom you and your party are really concerned. You may say that it would hurt auto industry, employment and so in. How does oil price affect the demand for automobiles (SUVs or luxury cars)? We have to look at the coefficient of own price elasticity and cross-price elasticity of demand. Does anybody have any figures of cross-price elasticity, price elasticity, and income elasticity of automobiles demand? When I searched on google scholars “the determinants of automobile demand in India”, I did not find any article. However, the available world literature suggests income, rather than both price and cross-price elasticity, is a bigger factor in the decision to purchase luxury cars. In the Indian context we have to find out which elasticity is bigger: income or price? If income, surely it merits to tax luxury cars. If this is true, then it would not kill much employment. It is surprising that you even did not talk about investment on alternative energy source. Providing enough support to invest in clean energy would also create new employment opportunities.