Onion Price Rise: Searching for the Bad Guy?

Everybody is commenting on India’s onion price rise. The pseudo-economist in me also urged me to comment something. So, my two cents are here.

Onion always brings tears to our eyes: When its price rises it brings tears, when its price falls, it also brings tears. So, this time when price of onion rose to Rs 61/KG, government again blamed onion hoarders and bad monsoon. It is not new thing to read government blaming price rise of vegetables to hoarders.  As usual, it is believed that government also ordered raids on godowns where vegetables are stored.

The questions are:

1.      Is it a demand-supply mismatch?

2.      Is it due to bad monsoon?

3.      Is it the hoarder, the bad guy?

4.      Finally, is it the government policy like no MSP for onion and no cold storage for vegetables?

This Wall Street Journal piece made me little uncomfortable in digesting the cause and remedial measures. For the uninitiated, without reading you can guess correctly what the article is arguing. Because the name WSJ itself is sufficient. They will say hoarders are not responsible, it the mistake of market (I mean, the demand-supply mismatch) and let the government watch the situation and let the market take care of onion price rise. Well, they say that bad monsoon and market speculations are also partly responsible. They say:

Of course, weather and market speculation play a part but the fundamental issue is a supply and demand mismatch that is causing the volatility, not an onion mafia. Demand for onions is rising along with the incomes of the average Indian. But farmers are discouraged from growing enough onions because of government interventions aimed at keeping prices down.

Hmm…..that is okay. But then they quote this:

When onion prices rise, the government steps in to block profitable exports and to knock down domestic prices, said Changdev Holkar, former director of the state-run National Agricultural Cooperative Marketing Federation of India Ltd.

I have a little problem here. If you analyze two statements here you see they talk about demand-supply mismatch and profitable exports. By profitable exports they mean export price has risen. Thus, the question is which demand-supply mismatch they are talking about: India or Global? I think it is pretty clear that they are talking global demand-supply mismatch. If this is so, then global demand-supply mismatch should be blamed for domestic demand-supply mismatch. Think of this. Suppose the demand = supply in the domestic market. But global demand > global supply. As a result, global price rises. Seeing higher price and higher profitable opportunities, domestic (Indian) producers, read TRADERS, will export more. And this will cause a domestic demand-supply imbalance. If this argument is right, then I think banning exports is a solution in right direction. Another way to think is when domestic price is rising why are they still selling in foreign market or exporting? Obviously, the export price is higher (marginally or substantially?) than domestic price. Else, they won’t export, right? If you ban exports, then traders cry foul.

The other non-trivial question is: what kind of good is onion (from a microeconomics point of view): Normal, or inferior?  

When import price becomes cheap, why do domestic corporates cry foul and urge government to ban imports or raise import prices?  Why do they do that? If due to global demand-supply mismatch (demand > supply) domestic consumers has to pay a higher price, then why do they complain when global demand-supply mismatch (supply > demand) results global price plummet and consumers also want to benefit from that? Why don’t you advise government then to tie its hand and let the market do the job?

It also argues for MSP for onion. Though, I have sympathy for this suggestion, yet the pricing or MSP hikes become more political. Some economists squarely blame food inflation to MSP hikes. They argue MSP hikes are not correlated with cost hikes and is is motivated by election. Thus, when there is a growing demand for MSP abolition of certain commodities, to what extent this suggestion (MSP for onion) makes sense has to be evaluated carefully. I leave it to you.

How to Accept (Reject) Recommendations/ Suggestions?

Suppose a book or an expert on a chosen field has set of recommendations for the government to solve a social or economic problem of the day. For example, Tony Atkinson in his book Inequality: What Can Be Done? has given 15 recommendations to solve the problem of rising and severe inequality. Or think like this. A government has instituted a commission to suggest some policy measures to solve the issue of inequality. The committee comes out with a bunch of recommendations. Now all these suggestions will be discussed and debated vociferously. It will continue for months. A government concerned about rising inequality wants to do something to reduce it.  My puzzle is this:

1.      Out of top 10 inequality experts, six experts accept recommendations #1 through #10 and reject #11 through #15. And the other four experts reject #1 through #10 and accept #11 through #15. In effect we see all recommendations are rejected and accepted. What should a government wanting to implement some of recommendations do? The question before the government is: Which one it should accept (reject) and why?

2.      In the process of intense discussions top experts in the field will reject some recommendations and will accept some. So, if there are 30 big stars in inequality research, then 15 accepting strongly all recommendations and 15 rejecting strongly how to accept those recommendations?

So, how to accept recommendations when there is a sharp divide among experts ? On what basis?

I have one suggestion. Instead of asking the experts to say yes/no, we can ask each expert to place their confidence or weights behind all suggestions. Then we will aggregate all confidence or weights. The recommendation having highest confidence will be the chosen over others for government action. Will it solve the puzzle mentioned above? It may not because when an expert says yes (no), he may give 100% weight or 90% weightage. But it will be very effective when experts are uncertain about the efficacy of recommendations. If experts give their views unbiasedly then this weighting scheme will work better.

Tax Slab, Inflation and Government Revenue

Suppose the tax slab is like the following:

(Figures in Rupees)

Tax bracket   Tax rate        Actual income  Income when indexed with inflation

0-3L                   0%                 2.9L                   3.045L

3.01-5L                10%               4.9L                   5.145L

5.01-10L              20%               9.9L                   10.4L

Start with an inflation rate of 0%. Assume that one’s income falls in the first category where he does not have to pay tax. Now inflation climbs up to, say, 5%. Assume that in the economy, people’s income/salary is tied to the inflation rate. As a result, see what happens to the fourth column. Now one’s income has shifted to tax category. For example, in the first case, as his income has risen to above 3lakhs (3.045L to be precise) as a result of salary tied with inflation, he has to pay a flat 10% income tax which is (3.045-3)*10%=Rs 1450.

Imagine how much money the government is collecting income tax due to this slab system.

So, if the government has data regarding mean income of each tax slab, and if income is indexed, this example shows government can create the necessary amount of inflation so as to push them to the next tax slab where they have to pay tax. In this way government can collect revenue.

But does it make sense for the government given that people dislike inflation and government will earn a public ire? If the mean income in the tax slab is close to the upper boarder (that is, close to 3L in the exempted tax slab), then government may go for it. If the average income is much lower than the upper boarder, then it has no incentive to create more inflation so as to push the tax payers to the next tax slab. But here’s is the catch. If government is seriously considering generating revenue through this way, then it can redesign the tax slab very close to the average income in each tax slab. For example, in the first category which is exempted, the mean income is, say, 2.4L. So, the government can redesign the tax slab in the budget from 0-2.5L. Then with little effort it can push the inflation.