Price Fixing and the Law of Unintended Consequences



One of the beliefs that governments and regulators have is that they can control prices. All that is needed is a government decree fixing the price of a particular product and everything will fall into place.

But is that how things eventually work out? The answer is no. The first point here is that letting the market work and evolve a certain price of a product is very important, otherwise it leads to unintended consequences.

The law of unintended consequences essentially states that purposeful actions of the government have unintended or unanticipated consequences, the noble intentions of the government notwithstanding. Take the case of glass production in the erstwhile Soviet Union. Everything was government owned and like other things, the government produced glass as well.

The idea of course was to produce different types of glass and enough glass. The trouble was that there was no pricing mechanism in place, which could inherently coordinate the demand and supply of different kinds of glass. All that was in place were government diktats.

As Swaminathan S Anklesaria Aiyar writes in From Narsimha Rao to Narendra Modi—25 Years of Swaminomics: “In the absence of pricing mechanisms, Soviet planners set physical targets of glass production in terms of weight, factory managers started producing the heaviest sorts of glasses to meet plan targets. This meant shortages in terms of square feet.”

The planners then decided to shift the targets from tonnes to square feet in order to correct for this unintended consequence. “Alas, this induced factories to produce the thinnest glasses to meet targets, and much of it shattered,” writes Aiyar.

The point being that when the government tries to interference with a pricing mechanism of a product, it has unintended consequences which are not good for the overall economy. Aiyar provides another excellent example of this phenomenon, in his book.

He talks about the days when India had only two car companies Hindustan Motors and Premier Automobiles. Those were also the days when the government fixed the price of a new car. And this had unintended consequences.

As Aiyar writes: “There was a long queue of several years to buy a car, and only people with contacts could get early delivery. The price of new cars was controlled by the government in the 1970s, but not of old cars. So, second hand cars cost more than new cars! As an accredited journalist, I was entitled to a car from the government, and I bought a Fiat car for Rs 22,000 in 1972.  I sold it for Rs 35,000 after five years of use.” These days the moment a car leaves a showroom it’s price comes down by as much as 30 per cent.

Nevertheless, the government continues to believe in price control mechanisms. Recently, the National Pharmaceutical Pricing Authority, put a price cap on stents which are used to open blocked arteries in the heart. Of course, those who pass such diktats have really no idea of how any market economy works.

Companies in the high-end stent business now want to withdraw stents from the market because these high-end stents are no longer viable at the price set by the government. Also, as happens in most cases where prices are capped, eventually the market for stents will move into the black economy. Those who can afford it, will settle in cash, or simply go abroad and get the procedure done and get the best stent available.

The hospitals which obviously made a cut from the stents that they sold can simply charge more for other procedures, in order to ensure that their revenues don’t fall. From the little anecdotal evidence that is available that has already started to happen. There have also been newsreports of high-end stents disappearing from the market.

In a column in the Mumbai Mirror on February 18, earlier this year, Dr Sanjay Oak had made a very sensible suggestion when he said that the government should “adopt an a la carte approach, making available stents at Rs 7000, Rs 28000, Rs 85000 and uncapped”. The way things currently are, the government diktat treats all stents to be the same.

And this as we have seen is having and will continue to have unanticipated consequences.

The column originally appeared in the Bangalore Mirror on May 3, 2017

Viral Acharya is Right About Re-privatising Public Sector Banks


Late last week Viral Acharya, a deputy governor of the Reserve Bank of India (RBI), said: “Perhaps re-privatising some of the nationalised banks is an idea whose time has come … this would reduce the overall money government needs to inject as bank capital.”

Regular readers of the Diary would know that we have said several times in the past that public sector banks should be privatised and the government should get out of the banking business, which it is clearly inept at.

Of course, the question is why has Acharya used the term re-privatising rather than privatising. Indira Gandhi nationalised 14 private banks on July 19, 1969. These banks had deposits of Rs 50 crore or more and among them accounted for 90 per cent of the banking business in the country. The funny thing is that at the time this happened, the then RBI governor LK Jha had no clue about it.

As TCA Srinivasa Raghavan writes in Dialogue of the Deaf—The Government and the RBI: “Volume three of RBI’s official history says that on July 17 she [Indira Gandhi] asked LK Jha, the RBI governor to come over to Delhi. Jha thought he was being asked to discuss social control and he took with him a comprehensive note on the subject. When he offered it to Mrs Gandhi she told him ‘that he could keep the note on her table and go to the next room and help in drafting the legislation on nationalising the banks.’”

In 1980, six other private banks were nationalised. This time the recommendation came from the then RBI governor, IG Patel.

Now getting back to what Acharya said, re-privatising is something we have advocated in the past. And it makes sense at multiple levels. We now have nearly two decades of evidence that suggests that the new generation private sector banks which were first set up in the mid-1990s, are much more efficiently run than their public-sector counterparts. Yes, there have been cases like the Global Trust Bank, but on the whole private banks are better run than their public sector counterparts. Even the old generation private sector banks, which are very small, are reasonably well run.

Take the case of the bad loans situation that currently plagues the Indian banking sector in general and the public sector banks in particular. As on December 31, 2016, the total bad loans of the public sector banks (gross non-performing assets (NPAs)) had stood at around Rs 6.46 lakh crore.

For the private sector banks, the same number stood at Rs 86,124 crore. Of this, two banks, ICICI Bank and Axis Bank, accounted for bad loans of Rs 58,184 crore. Of course, given that public sector banks give out more loans, it is not surprising that their bad loans are more.

The total loans of public sector banks are 2.9 times the total loans of private sector banks. But their bad loans are 7.5 times that of private banks. If both these set of banks were equally well run, then the two ratios just referred to, wouldn’t have been different.

Between 2013-2014 and 2015-2016, the total net profit made by the public sector banks stood at Rs 56,567 crore and that of private banks stood at Rs 1,13,801 crore. This, even though public sector banks are significantly bigger than India’s private banks.

These data points tell us that India’s public sector banks are inefficiently run. And this inefficiency has cost the government a lot of money over the years. Between 2009 and March 2017, the government has had to invest close to Rs 1.5 lakh crore in these banks to keep recapitalising their capital, in order to keep them going.

Indeed, this is a lot of money and could have gone towards other worthy causes. The basic problem with public sector banks is political meddling. Every government has its favourite set of industrialists and this ultimately leads to the public sector banks and in the process the taxpayer, picking up the bill for this politician-businessman nexus.

As Acharya writes in a paper titled Is State Ownership in the Indian Banking Sector Desirable?: “One, state ownership creates severe moral hazard of directing bank lending for politically expedient goals and of bailouts when such lending goes bad. Second, state ownership restricts the ability of state-owned banks from raising arm’s length capital against state’s stake, strangling their growth and keeping these banks—and certainly their private capital base—smaller than it need be.”

What does this mean in simple English? The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.” Hence, managers of government owned banks know that if loans given to businessmen close to politicians go bad, the government will ultimately pick up the tab by recapitalising the public sector bank to an adequate extent. Hence, they go easy on giving loans to borrowers who are likely to default. Of course, there is always the threat of transfers, which works very well. This has happened for years at end.

Secondly, given that the government has to continue owning a certain proportion of shareholding in these banks, the banks cannot raise as much capital as they require. They have to continue to be dependent on the government for capital. And the government of course does not have an unlimited amount of cash. This limits the ability of the government owned banks to raise as much capital as they may require at any point of time.

So, what are the actual chances of the government re-privatising some of the public sector banks, as suggested by Acharya? Zero. While Acharya, I and others, might think that the basic problem with public sector banks is government ownership, politicians don’t think so. This comes from the belief that if you own banks then you can direct lending to areas that you want to. But this as we have seen comes with its own set of costs.

The column originally appeared on Equitymaster on May 3, 2017.

Now that RERA is a reality, should you buy an under-construction property?


The Real Estate (Regulation and Development) Act, 2016, or RERA for short, has come into effect from May 1, 2017.

With this happening, the question on everybody’s lips is, should we buy an under-construction property? If you plan to buy a home to live in, an under-construction property makes sense because it comes cheaper than a finished one. If you plan to buy home as an investment, given that an under-construction property is cheaper, the returns are always better, depending how early in the construction stage you make the investment.

But that it the theoretical part of it. It comes with the assumption that the builder will deliver the property for which you have paid, and he will deliver it on time. The problem is that this does not always turn out to be the case. Many people in the Delhi National Capital Territory region and other parts of the country, have found this out in the last few years.

In the process, they have ended up paying EMIs on the home loans they had taken to fund their home purchase and the rent on the home in which they continue to live in. The homes they had hoped to live in are nowhere in sight.

But all this happened in era when there was no RERA. Now we have RERA. The real estate sector in the country up until now had next to no regulation from the point of view of the buyer. Buying a house required a lot of leap of faith and prayers at the same time.

The RERA essentially has these five basic purposes: a) to make sure that home that has been bought is delivered on time. b) to make sure what has been promised has been delivered with respect to the actual size of the house, the facilities etc. c) to make sure that the money taken from the buyer is used to build what has been promised and is not diverted to something else, as many builders tend to do. They tend to raise money for one project and then use it to finance another project. d) to make sure that the many permissions required to build a housing project are in place. e) to make sure that if any changes are made to the project, they have the approval of the majority of the buyers.

RERA also makes it mandatory for state governments to set up a real estate regulator. As the Act states that: “Any aggrieved person may file a complaint with the Authority [i.e., the real estate regulator of a particular state] or the adjudicating officer, as the case may be, for any violation or contravention of the provisions of this Act.”

What this basically means that if the builder takes the buyer for a ride, he can approach the real estate regulator and hope to set things right. This is precisely why there have been a flood of acche din articles in the media saying how RERA is going to save the day for real estate buyers.

There are multiple problems here:

a) While RERA is a central Act, land is a state subject. Hence, states are allowed to make the operational rules to implement RERA. Given the nexus that prevails between state level politicians and builders, state governments have already started diluting the basic spirit of RERA. In particular, an effort is being made to ensure that the ongoing projects are not brought under the ambit of RERA. This basically means that many buyers who are currently in trouble will not be able to benefit from this Act.

b) Only three states (Maharashtra, Rajasthan and Madhya Pradesh) have set up regulators up until now. Hence, the process of setting up a regulator is going to take some time.

c) It is important to understand that regulators don’t start becoming effective from day one. Take the case of the Securities and Exchange Board of India, the stock market regulator. It was set up in 1992 and in 1994 the vanishing companies scam, one of the biggest stock market scams, happened. This was followed by the Ketan Parekh scam in 1999-2000. Hence, it takes time for regulators to mature.

d) Also, it is important to know that the regulators don’t necessarily bat for the consumers. The Insurance Regulatory and Development Authority(IRDA) of India, the insurance regulator, for a very long time, turned a blind eye to all the misselling carried out by the insurance companies. It kept clearing investment plans which worked well for the insurance agents but not for the consumers who had bought them. The point being whether real estate regulators bat for the consumers or the builders, remains to be seen. Also, this is something that may vary from state to state.

To conclude, there are many practical things which continue to remain unclear as of now. Hence, if you are looking to buy a home to live in, it makes sense to still buy a fully finished one, rather than something which is under-construction. This may mean compromising on the size or the location, perhaps, but what you will get in return is peace of mind. And nothing is more important than that.

The column originally appeared on Business Standard The column originally appeared on Business Standard online on May 3, 2017.

One Friday, the Day the Cynic in Me Died, Just Briefly!


My Education Predisposes Me to See the Worst – Howard Jacobson, The Dog’s Last Walk (and other pieces)

Dear Reader,

One of the things I regularly get accused of is being overly pessimistic and cynical about most things in life. Well, I guess that is the way I am.

If you had grown up in erstwhile Bihar governed (for the lack of a better word, given that I don’t like using the world ruled) by Lalu Prasad Yadav and his wife Rabri Devi, where one power cut lasted for more than two weeks in the month of May, nearly dropped out of an MBA, dropped out of a PhD programme and finally ended up working in journalism for seven years, you would have probably also turned out the same way as I have.

But we have no way of figuring out that counterfactual.

My mind, the way it has evolved predisposes me to be cynical about most things around me. Having said that, the other day I saw something which really killed the cynic in me, however briefly.

So, it was Friday night and I was trying to figure out what to cook. (Well, all you men out there who read my pieces, of course, you have no idea about how this works. But when you have been cooking regularly for 15 years, as I have, believe me it does become a chore after a point of time, and a very boring one that too. So, hats off to all the women who have been cooking for their families every day for years at end). I had run out of onions and tomatoes and given the quick cooking I believe in, onions and tomatoes are the most necessary ingredients in anything and everything I cook.

So, I stepped out to buy vegetables for a change, Big Basket be dammed, given that they don’t deliver at short notice and the waiting time over the weekend can even be greater than 48 hours at times.

Close to where I live there is a Sports Club and a ground attached to it. Typically, as is common in Mumbai, the ground is used more for weddings and religious functions, rather than sporting activities. But I guess that is the way things are in a city which really lacks space. Free spaces need to be shared by everybody for different kind of activities and that is what happens.

The ground had a bunch of vegetable and fruit sellers who did not look like the regular vegetable and fruit sellers, from the vegetable market situated just next to it. This caught my curiosity and I went in. It turned out that the vegetable and fruit sellers were basically a bunch of farmers who had driven down from in and around Nashik.

This was a weekly market which was open from 4PM to 9PM on every Friday, I was told. Apparently, the market had been running for close to three months, but I only just came to know of it. So, I went around buying all the vegetables and fruits that I did need and that I did not need as well.

The vegetables and fruits were very fresh and the price very competitive to the nearby market. I bought grapes for Rs 50 a kg, something I have never done in the nearly 12 years that I have lived in Mumbai. I also bought red capsicum that fancy vegetable which stores like Nature’s Basket sell for as high as Rs 300 a kg, at Rs 40 a kg.

Also, farmers selling the vegetables and fruits claimed that the fruits had not been aged using chemicals. I am no expert on this, but what I can tell you is that the grapes and the mangoes that I bought at the market were simply out of this world.

I spoke to a few farmers at the market and they were very happy in being able to sell to the public directly. There were multiple reasons for the same. First, they got a better price for their produce with the middle men out of the way. Second, they got their money immediately instead of when they sold their produce to an agent at a mandi, up until last year. Third, lesser amount of vegetables and fruits were wasted given that what was produced was sold almost immediately.

This is an impact of a decision that the Maharashtra government took in June last year. It basically allowed farmers to sell their produce in the open market. Up until then the farmers could only sell their produce to traders licensed by the Agriculture Produce Marketing Committees(APMCs).

This essentially meant that the farmers were not in a position to determine the price of what they had produced and had to take what was offered. How can any entrepreneur, which is what farmers are, not have a role in determining the price of what he produces, is something beyond my understanding? This again comes from the socialistic attitude of government knows best, something that we haven’t been able to get rid-off in a long time.

As is well known APMCs across the state of Maharashtra have traditionally been controlled by those belonging to the Nationalist Congress Party (NCP).

The dismantling of compulsory selling to APMC traders has led to the creation of markets like the one I went to last Friday. Newsreports suggest that there are a few hundred of these markets across the state of Maharashtra. This is also an excellent example of how any government can enable citizens to carry out their work honestly, by getting rid of provisions which hamper the ease of doing business.

The returns on farming as an economic activity have been falling over the years. This comes from the simple fact that over the generations, farms have been divided and the average size of a farm in India is now very small, at close to 1.2 hectare. Hence, more and more people need to be moved away from farming towards other economic activities.

But given that is not happening any time soon and may take many decades (if at all), something needs to be done in the intermediate period as well. Helping the farmers get closer to the consumer is one such thing. It helps the farmer get better prices for his produce. It also helps consumers buy vegetables and fruits at a lower price. The only person who loses out is the middleman affiliated to a political party.

This is something that needs to happen throughout the length and the breadth of the country. Farmer markets need to bloom. Nevertheless, as a report in the Mint points out, only “15 states allowed the delisting of fruits and vegetables from APMCs, making it possible for farmers to sell these outside regulated markets.” This tells us that other states are still bowing to the pressure from the trader lobbies.

Also, the states are hesitating in opening up totally on this front. As the Mint points out: “Many states have amended their marketing acts but are yet to notify rules. Maharashtra, for instance, delisted fruits and vegetables a year back but did not notify rules following pressure from the powerful traders’ lobby.”

And this is why the cynic in me died on one Friday, but only briefly.

The column originally appeared on May 2, 2017, on Equitymaster.