Henry Hazlitt

Trump’s Trade Wars Aren’t Going to Make America Great Again

donald trump
Donald Trump’s campaign slogan while fighting the American presidential elections, was to ‘Make America Great Again’. On March 1, 2018, a little over a year after taking over as the 45th president of the United States, Trump announced a 25% tariff on steel and a 10% tariff on aluminium.

The question is, how does this fit into Trump’s plan to make America great again? Trump plans to drive up exports and drive down imports. By driving down imports through tariffs, the American consumer will be forced to buy stuff produced within the country. This will encourage domestic industry and in turn create jobs. By driving up exports, again domestic industry will be encouraged and this will create jobs. QED.

Now only if it was as simple as that. The trouble is that most politicians while making economic decisions look at only the first order effects of their decisions. In the current case this basically means that the steel tariff of 25%, will also allow the American domestic steel industry to compete.

As of now the American steel industry cannot compete simply because it cannot produce steel at a price at which steel can be imported into the United States. The tariff of 25% will make imported steel costlier and in the process allow American steel companies to compete. And this will create jobs. At least that is what Trump and his advisers who have helped him to arrive at this decision, hope for.

This is the first order effect of Trump’s decision which looks just at the impact of the tariff  on the American steel producers. As Henry Hazlitt writes in Economics in One Lesson: “Those who favour it [i.e. tariffs] think only of the interests of the producers immediately benefitted by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties.”

Hazlitt is talking about the first order effect of Trump’s decision which benefits American steel companies and the second order effect of Trump’s decision which hurts American companies consuming steel.

Steel (either imported or produced in America) is bought by other American companies. It is used as a major component while making buildings, tools, ships, automobiles, machines, appliances, and weapons. Other than weapons, the United States cannot do without the other things listed in the last sentence.

On second thought, given the American obsession with guns, neither can the country do without weapons.

Steel is also used as a major input into building physical infrastructure.

While the tariff on steel will make American steel producers viable, it will make steel more expensive for American steel consumers, as they will have to pay more for steel. This increase in cost will be passed on to the end consumers. So, everything from cars to appliances to homes will cost more. The end consumer only has so much money going around. Hence, he or she may not buy the stuff he has been planning to, due to higher prices. If he does so, his expenses will have to increase or he will have to balance his overall expenses, by cutting down on his other expenditure.

As Hazlitt writes: “The added amount which consumers pay for a tariff protected article leaves them just that much less with which to buy all other articles. There is no net gain to industry as a whole.” This is a very basic point which politicians encouraging any sort of protectionism don’t seem to get.

The tariffs will impact the overall sales of other American businesses, which might in turn fire people to maintain their profitability. It’s just that it is not possible to exactly quantify these job losses and loss of business.

As Hazlitt writes: “It would be impossible for even the cleverest statistician to know precisely what the incidence of the loss of other jobs had been—precisely how many men and women had been laid off from each particular industry, precisely how much business each particular industry had lost—because consumer had to pay more [for steel in this case].”

The news agency Reuters has a story on how 780 workers of the Novolipetsk Steel will lose their jobs. The company imports two million tonnes of steel slabs per year from its Russian parent company. It then rolls these slabs into sheets for various American companies, ranging from Home Depot to Harley Davidson to Caterpillar.

The customers of this steel company now need to be ready to accept a 25% increase in the price of steel. If they do, the company survives. If they don’t, then the company will have to start firing workers. This is the second order effect of a tariff, which is not very clear up front.

If these companies accept a 25% increase it will only be in a situation where they can’t source the steel they need from a cheaper source. Further, it will lead to a rise in the price of their end product, depending on what proportion steel forms of their total inputs.

Also, it is worth remembering here, that if America can impose tariffs on its imports, other countries can do the same on their imports, hurting American exports. In fact, this is precisely how things played out in the aftermath of the First World War, when America tried to protect its domestic industry through tariffs. In return, other countries imposed tariffs on their imports and this led to the start of the global trade war, hurting American exports.

Hence, driving down imports, while trying to drive up exports, is sort of contradictory. There are many other aspects to this, which we shall see in tomorrow’s column.

The Economist estimates that steel and aluminium accounted for around 2% of the total American imports of $2.4 trillion, last year. This formed around 0.2% of the American GDP. Given this, currently the level of protectionism unleashed by the American president is very small. But the level of rhetoric that Donald Trump has unleashed around the issue, it doesn’t seem that he is going to stop just at this. This also becomes clear from the fact that on March 6, 2018, Gary Cohn, the chief economic adviser of Trump, quit.

We will return to this discussion in tomorrow’s column.

The column originally appeared on Equitymaster on March 12, 2018.

Shutting Out Chinese Products is Not Going to Create Jobs

Public rallies against imported Chinese goods are held quite regularly these days, across different parts of the country. India’s dependence on Chinese goods has only grown over the years. This can be made out from Figure 1, which plots India’s imports from China every quarter, for the last few years.

Figure 1 tells us very clearly that India’s imports from China have grown over the years. Having said that, it doesn’t make sense to look at imports in isolation given that India exports stuff to China as well. Hence, Figure 2 plots India’s trade deficit with China (i.e. the difference between our total imports from China and our total exports to it).

Figure 1:
Figure 2 clearly shows that India’s trade deficit with China has grown over the years. This means that we import much more from China than we export to it. A major reason for this lies in the fact that most of the Indian firms are small in size. Take a look at Figure 3.

Figure 2:
What does Figure 3 tell us? It tells us very clearly that close to 85 per cent of Indian manufacturing firms are small. They employ less than 50 workers. In case of China, only around 25 per cent of the manufacturing firms are small. Also, in case of China, more than 50 per cent of manufacturing firms are large i.e. they employ more than 200 workers. In the Indian case, around 10 per cent of the manufacturing firms are large. And India has very few middle-sized firms which employ anywhere between 50 to 200 workers.

Figure 3: Distribution of manufacturing workforce among small,
medium and large firms in India and China
Given this small size, Indian firms lack economy of scale, which is basically a proportionate fall in costs gained with increased production. Hence, Indian products are costlier than Chinese products. In a recent newsreport, Blooomberg quotes a small shopkeeper as saying: “India-made lights cost twice as much… Customers aren’t willing to pay that.”

The other factor that helps make Chinese imports cheaper is the huge fall in international shipping costs over the years. This is a point that Tim Harford makes in his new book 50 Things That Made the Modern Economy: “Goods can now be shipped reliably, swiftly and cheaply: rather than the $420 that a customer would have paid… to ship a tonne of goods across the Atlantic in 1954, you might now pay less than $50 a tonne.”

This has had a major impact on the way goods are manufactured and business in general is carried out. As Harford writes: “Manufacturers are less and less interested in positioning their factories close to their customers – or even their suppliers. What matters instead is finding a location where the workforce, the regulations, the tax regime and the going wage all help make production as efficient as possible. Workers in China enjoy new opportunities; in developed countries [and developing countries] they experience new threats to their jobs; and governments anywhere feel that they’re competing with governments everywhere to attract business investment. On top of it all, in a sense, is the consumer, who enjoys the greatest possible range of the cheapest possible products – toys, phones, clothes, anything [emphasis added].”

The point is that the Chinese factories operate on a very large scale and that makes their products cheaper than the ones being made in India. The fact that transportation costs are low, helps as well.

Those against Chinese products want this dominance of Chinese products on India to end. As Arun Ojha, national convener of Swadeshi Jagran Manch recently told Bloomberg: “Our youth are losing jobs and we are becoming traders of Chinese products.”

It is important to dissect Ojha’s statement. What he is essentially saying is that because Indians are buying Chinese products, Indian industry is shutting down and the Indian youth are losing jobs. So, what is the way out? The way out is that we stop buying Chinese products and start buying Indian ones. Will this help?

This is where things are no longer as straightforward as they seem. The straightforward interpretation here is that, as Indians stop buying Chinese goods and start buying Indian goods, Indian industry will flourish, and Indian youth will find jobs. Now only if it was as simple as that.

Henry Hazlitt discusses a similar situation in his brilliant book Economics in One Lesson, in the context of United Kingdom of Great Britain and United States of America. As he writes: “An American manufacturer of woollen sweaters… sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circle.”

An American manufacturer of sweaters can sell his sweaters for $ 30 per piece. At the same time, an English manufacturer can sell the same sweater for $25 per piece. Hence, the American manufacturer charges $5 or20 per cent more for the same product than the British one. Of course, if both the products are allowed into the American market, the consumer will buy the cheaper one. This would mean that the British manufacturer would flourish. In the process, the American manufacturer might have to shutdown and this would mean a loss of a huge number of jobs.

The American government would obviously be bothered about the American manufacturer and the American jobs. Given this, to ensure that the American manufacturer can compete, the American government needs to impose a duty of $5 on the British manufacturer. This will mean the British manufacturer will also sell sweaters for $30. In the process, the American manufacturer would be able to compete, and jobs would be saved.

This trouble with this argument, as convincing as it sounds, is that it does not take the point of view of the consumer buying the sweater into account. As Hazlitt puts it: “The fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence.”

If the consumer ends up paying $30 per sweater, he would be paying $5 more. This basically means that he would have $5 less to spend on other things. As Hazlitt writes: “Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woollen sweater industry, 50,000 fewer persons would be employed elsewhere.”

If the British manufacturer was allowed a level playing field and sweaters continued to sell at $25 per piece, the American manufacturer would soon have to shutdown. The loss of these 50,000 jobs would be noticed. This would be the seen effect of letting the British sell in the American market.

If these jobs are to be protected, then even the British sweaters would have to sell at $30 per piece. This would leave the consumer with $5 less, which he could have spent on something else, otherwise. This lack of spending would impact other industries and jobs would be lost there. It’s just that the loss of these jobs would not be so visible as was the case with the American sweater industry. This is the unseen effect.

Now replace the United States with India and the United Kingdom with China in the above example, the entire logic remains the same. If Indians move towards buying more Indian goods than Chinese, they will end up paying more for those goods. This will leave them with less money to spend elsewhere. This would impact other industries, where jobs would be lost. It’s just that these job losses won’t be so obvious.

This is a rather obvious point that most people miss out on while analysing this issue. There is a certain opportunity cost of money. As Dan Ariely and Jeff Kreisler write in Dollars and Sense-Money Mishaps and How to Avoid Them: “The opportunity cost of money is that when we spend money on one thing, it’s money that we cannot spend on something else, neither right now nor anytime later.”

Given this, shutting out Chinese products is not going to create jobs in India. The only way jobs can be created is if Indian industry can compete with China. Right now, it doesn’t.

The column originally appeared in Equitymaster on Nov 27, 2017.

Govt Fixing Steel Prices: Is Make in India Just a Slogan?

make in india
On February 5, 2016, the directorate general of foreign trade imposed a minimum import price(MIP) on 173 steel products. The prices range from $352 per tonne to $752 per tonne of steel.

The MIP has been imposed in order to counter the dumping of cheap Chinese steel and should help the Indian steel companies. Also, the move should help public sector banks as well.

Why do I say that? As the RBI Financial Stability Report released in December 2015 points out: “A risk profile of select industries as at end September 2015 showed that iron and steel, construction and power industries had relatively high leverage as well as interest burden.”

The report further pointed out: “Five sub-sectors viz. mining, iron & steel, textiles,  infrastructure and aviation, which together constituted 24.2 per cent of the total advances of scheduled commercial banks as of June 2015, contributed to 53.0 per cent of the total stressed advances.”

What does this tell us? Steel companies have borrowed a lot of money from banks which they are now finding difficult to repay. The only way they can repay these loans is by ensuring that their sales and profits continue to grow. And that is not possible if cheap steel from China keeps hitting the Indian shores.

The government has tried to correct this by slapping an MIP on steel, in the process making imported steel more expensive. The idea is that anyone who needs steel within India, buys from Indian companies, instead of importing cheaper steel.

The question is does this make sense? It does for the steel companies. But not for the overall Indian economy as a whole. Before I get into explaining this, allow me to discuss what is known as the broken window fallacy. The French economist Frédéric Bastiat discusses this concept in his 1874 book That Which is Seen, and That Which is Not Seen.

Bastiat talks about a shopkeeper whose rather careless son has broken a glass window of his shop. As Basitat writes: “If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—“It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”

The point being if window glasses were never broken what would glaziers ever do? As Basitat writes: “Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it, I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.”

But what about that which is not seen? “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented,” writes Bastiat.

What is Bastiat trying to tell us here? When we are analysing economic issues, we tend to look at that which is seen and tend to ignore that which is unseen. In the case of minimum import price being fixed on steel imports, it means looking only at the benefits that this would bring to the Indian steel companies.

Stock analysts have labelled this move of the government as a “gamechanger” for the steel companies and have recommended that investors buy these stocks.  Now that is the ‘seen’ part of it, if we were to apply Bastiat’s broken window fallacy to this situation. But what about the unseen?

As Henry Hazlitt writes in Economics in one Lesson: “The tariff has been described as a means of benefitting the producer at the expense of the consumer. In a sense this is correct. Those who favour it only think of the interests of the producers immediately benefited by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties.”

A tariff is essentially a tax or a duty that is paid on imports of exports. In the case of the minimum import price on steel imports, no duty has been fixed or tax has to be paid. But given that the minimum import price will force consumers of steel to buy steel at a higher price from Indian steel companies, it basically means that the companies are being forced to pay more than they would have, if this move had not been made. In that scenario they could have simply imported cheaper steel, which they cannot do now. Hence, to that extent even an MIP is basically a tariff.

Steel is an input into many different sectors from automobiles to real estate to engineering to construction and infrastructure. Hence, if the price of steel goes up, companies operating in these sectors need to pay more when they buy steel. And this in turn will impact the prices of the consumer goods that these companies produce and the physical infrastructure that they create. This is the unseen negative that people are not talking about.

Take the case of engineering goods, which is as of now, India’s number one export. As TS Bhasin, Chairman of EEPC India, an engineering goods exporters’ body, told The Hindu: “The MIP will raise the cost of raw materials for engineering products by about 6-10 per cent. This will severely hurt engineering exports that have already declined by 15 per cent in the first nine months of this fiscal.” How will Indian engineering companies compete globally in an environment of slow global economic growth, if steel is made expensive?

Further, this also leads to the question as to how serious is the government about “Make in India”. Is it just a slogan? Or is it more than a slogan? If it is more than a slogan then there is no way that the government should be fixing steel prices and in the process increasing the price the consumers of steel pay.

Also, why is the government just trying to protect steel producers. How about retail companies which have been bearing the onslaught of ecommerce companies selling goods at significantly lower prices, backed by foreign venture capital and private equity money?

As Anindya Banerjee, analyst at Kotak Securities puts it: “The offline retailers have been long complaining how ecommerce companies, funded by cheap dollars/euros/yen of yield hungry bubble vision private investors, is undercutting them in every consumer product. They claim that these ecommerce companies are destroying hard working mom and pop stores and their employees, by resorting to unsustainable discounts. So why is the government not imposing a minimum retail price(MRP) for all products sold online. This MRP should be set at a price which is above the offline retail price. I presume my fellow citizens won’t mind paying more for their stuff they buy. After all they are supporting the economy, aren’t they?”

Now that is something worth thinking about. And if something like that were to happen, we would be finally back to the eighties. My growing up years will  be back again.

The column originally appeared in The Five Minute Wraupup on Equitymaster on February 10, 2016

Of BJP and Congress: Why governments hate markets

light-diesel-oil-250x250Vivek Kaul

Over the years I have come to the conclusion that governments don’t like markets. Markets are too unpredictable for their taste. And they don’t do what the government wants them to do. They don’t move in directions the government wants them to. In short, markets can’t be controlled. Or to put it even more simply, markets have a mind of their own.
And no government likes that.
Hence, when the diesel price was decontrolled in October earlier this year, I had my doubts about how long will it last. The finance minister Arun Jaitley had said on that occasion “Henceforth, like petrol, the price of diesel would be linked to the market and therefore depending on whatever is the cost involved …the consumers will have to pay.”
At times things sound too good to be true. This was one of those statements. And now only a few weeks later, the government has sideline the market and decided to go about setting the price of petrol and diesel.
Earlier this week on December 2, 2014, the government decided to raise the excise duty on petrol and diesel. This was the second time the government increased the duty in less than a month. The excise duty on petrol was increased by Rs 2.25 per litre and that on diesel by one rupee per litre.
This increase in duty will not be felt at the consumer level. Nonetheless, if the government had not decided to increase the duty it would have meant that consumers would have benefited from a further fall in the price of petrol and diesel. Hence, the government is essentially creaming off the consumer surplus.
This also explains why the price of petrol and diesel in India hasn’t fallen as much as the global oil prices have. And that means the petrol and diesel prices are no longer linked to the market, as Jaitley would have had us believe only a few weeks back. As an editorial in the Business Standard points out: “If the government is forcing the oil marketing companies to set prices according to the dictates of political masters, then it can hardly claim deregulation has happened.”
The government is having a tough time meeting its expenditure and this is a very easy way to raise its income. The fiscal deficit for the first seven months of this financial year (April to October 2014) was at 89.6% of the annual target. Last year during the same period, the number was at 84.4%. Fiscal deficit is the difference between what a government earns and what it spends.
Hence, if the government has to meet its fiscal deficit target it has to increase its income or decrease its expenditure or possibly do both.
An editorial in The Indian Express points out that the two hikes in excise duty, will help the government earn an additional Rs 10,000 crore. This should come as a welcome relief for the government given that estimates now suggest that indirect tax collections will see a shortfall of around Rs 90,000 crore in comparison to what had been assumed at the time the budget was presented in July this year.
The editorial goes on to suggest that instead of increasing the excise duty the government could have levied a cess and collected that money to go towards a specific purpose like a national highway fund. But that hasn’t happened and the increase in the excise duty will just disappear into the consolidated fund of India.
But that’s just one part of the story. Every government has the right to increase or decrease taxes, after taking into account the situation that it is operating in. Nevertheless, if the government had allowed the market to operate, the oil marketing companies would have been allowed to pass on this increase in excise duty to the end consumer. The fact that they haven’t been allowed to do so means that the government is deciding on the price of petrol and diesel.
Further, now that the government has decided to set the price of petrol and diesel, it will be interesting to see what happens when the price of oil starts to go up again (That may not happen immediately with Saudi Arabia looking determined to drive down the price of oil to make US shale oil unviable, but its a possibility nonetheless).
The previous Congress led United Progressive Alliance(UPA) government did not allow the oil marketing companies to sell petrol and diesel at a price which was viable for them.
Instead, the government along with the upstream oil companies like ONGC and Oil India Ltd, compensated the oil marketing companies for their “under-recoveries”. This drove a huge hole into the government finances. The total oil subsidy bill during the period the Congress led UPA government ruled the country was a whopping Rs 8,30,000 crore. This along with other subsidies pushed up the government expenditure and in the process its fiscal deficit.
Once the government was borrowing more, it crowded out other borrowers as there was a lesser amount of money available for others to borrow. This pushed up interest rates. It also led to a rupee crisis between late May and August 2013, when the value of the rupee crashed against the dollar.
It had other repercussions as well. But before we get into that it’s important to repeat what Henry Hazlitt writes in Economics in One Lesson: “We cannot hold the price of any commodity below its market level without in time bringing about…consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are tempted to buy, and can afford to buy, more of it.”
This is precisely what happened in India. The demand for diesel went up because for a very long period of time the government completely delinked diesel prices to international oil prices. Hence, there was a substantial difference between the price of petrol and diesel. This led to a huge market in diesel cars. Given this, rich consumers ended up consuming more than their fair share of diesel.
As Hazlitt writes in this context: “Unless a subsidized commodity is completely rationed, it is those with the most purchasing power than can buy most of it. This means that they are being subsidized more than those with less purchasing power…What is forgotten is that subsidies are paid for by someone, and that no method has been discovered by which the community gets something for nothing.” So, while the rich went around in their diesel cars, the nation ended up with a huge subsidy bill.
Like the Congress led UPA before it, the current BJP led National Democratic Alliance (NDA) has decided to set the price of petrol and diesel and not leave it up to the market. There will be great pressure on the government to hold back the price of petrol and diesel, once oil prices start to go up again. And that as we have seen can be disastrous for the economy. 

The article was published on www.equitymaster.com on Dec 5, 2014

Deregulating diesel prices: A good decision that will be tested when oil prices rise again

light-diesel-oil-250x250

Vivek Kaul

The government on Saturday announced the decision to deregulate diesel prices. “Henceforth—like petrol—the price of diesel will be linked to the market,” the finance minister Arun Jaitley said after a cabinet meeting. “Whatever the cost involved, that is what consumer will have to pay,” he added.
After this decision the price of diesel was reduced by around Rs 3.50 per litre (the cut would vary all around India given the different rates of taxes in different states). This was the first cut in the price of diesel since January 2009.
The proposal to allow oil marketing companies to decide the price of diesel was first made in 1997, when Inder Kumar Gujral was the prime minister. The price of petrol and diesel were finally deregulated in April 2002, under the regime of Atal Bihari Vajpayee.
But this decision was over turned in late 2004, around the time oil prices had touched $50 per barrel. In November 2004, Mani Shankar Aiyar, the then Petroleum Minister said “since January 1, 2004, government was dictating even petrol and diesel prices… We have been far more honest in saying the government will control prices of cooking and auto fuels.”
This led to the oil marketing companies having to sell oil products at a price at which they incurred under-recoveries. The government compensated a part of these under-recoveries. And due to this the government expenditure and in turn, the fiscal deficit went up. Fiscal deficit is the difference between what a government earns and what it spends.
In the last two financial years (i.e. 2012-2013 and 2013-2014) the total petroleum subsidy (subsidy for diesel, cooking gas and kerosene) amounted to Rs 1,82,359.9 crore. As an article in The Wall Street Journal points out “Around half of that was for diesel. Before diesel prices were freed, economists estimated that a $1 per barrel rise in the global price of oil would increase India’s subsidy bill by around $1 billion a year.”
As government expenditure in order to pay for the under-recoveries of the oil marketing companies went up over the years, so did its borrowing. When the government borrows more, it crowds out the other borrowers i.e. it leaves lesser on the table for the private borrowers to borrow. This, in turn, pushes up interest rates, as the other borrowers now need to compete harder.
The high interest rate scenario that has prevailed in India over the last five-six years has been because of this increased government borrowing. If diesel prices had continued to be deregulated this wouldn’t have happened.
Other than the high interest rates, there were several other things that happened. But before we get into that let’s see what the economist Henry Hazlitt writes in Economics in One Lesson “We cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are tempted to buy, and can afford to buy, more of it…In addition to this production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business.”
The demand for diesel went up in the form of people buying more and more passenger cars that ran on diesel, given the substantial difference between the price of petrol and diesel. This led to the government of India indirectly subsidising car owners over the last few years. Hence, rich consumers ended up consuming more than their fair share of diesel.
As Hazlitt writes in this context: “Unless a subsidized commodity is completely rationed, it is those with the most purchasing power than can buy most of it. This means that they are being subsidized more than those with less purchasing power…What is forgotten is that subsidies are paid for by someone, and that no method has been discovered by which the community gets something for nothing.”
The move to dismantle diesel price deregulation also drove private marketers of oil (Reliance, Essar etc) out of business, as suggested by what Hazlitt had to say on the issue. The government owned oil marketing companies (Indian Oil, Bharat Petroleum, Hindustan Petroleum) were compensated by the government and the upstream oil companies (like ONGC, Oil India Ltd) for selling diesel at a lower price. There was no such compensation for the private oil marketers and hence, they had to shut down their business.
Once all these factors are taken into account the decision to deregulate diesel prices is a brilliant one even though it took a long time to come. Nevertheless, it will not lead to any major immediate benefits for the government. Since Narendra Modi took over as the prime minister of the country, the oil price has fallen dramatically.
As per the Petroleum Planning and Analysis Cell, the international crude oil price of Indian Basket as on October 17, 2014, stood at $ 85.06 per barrel. This price had stood at $108.05 per barrel on May 26, 2014, the day Modi took over as the prime minister.
Interestingly, during April to June 2014, the first quarter of this financial year, the under-recoveries of oil marketing companies on the sale of diesel, cooking gas and kerosene were at Rs 9,037 crore. This is much lower in comparison to the huge under-recoveries that these companies suffered over the last few years.
Also, since January 2013, the price of diesel has been raised by 50 paisa every month. This has led to the under-recoveries of oil marketing companies coming down significantly. Interestingly, for the fortnight starting October 16, 2014, the over-recovery on diesel stood at Rs 3.56 per litre. And that explains why the government was able to cut the price of diesel by around Rs 3.50 per litre.
What this tells us clearly is that there will be no immediate benefit on the fiscal front of diesel price deregulation to the government. Further, the real benefit of this reform will kick in only once oil prices start to rise. And it is at that point of time, the government of the day will have to resist any temptation to start controlling diesel prices, as has been the case in the past.
If it resists this temptation, the upstream oil companies (ONGC, Oil India) will also benefit because the government will not strip them of their profits to pay off the under-recoveries of the oil marketing companies. This explains why the share price of ONGC is up by more than 5% today.
Nevertheless, one immediate benefit of the diesel price cut will be a slightly lower inflation. On the flip side, this also means that if and when oil prices start to go up, the inflation will start reflecting a higher price of diesel more quickly than was the case in the past.
Another benefit of the deregulation will be that private marketers can now look to get back into the business. This is good news for the Indian consumer as it will mean more competition, which may lead to better services. In fact, one huge problem with the products sold by the public sector oil marketing companies is adulteration. Given the cheap price of kerosene, there is lot of adulteration of petrol and diesel. Private marketers can make in roads into the market by providing pure petrol and diesel, and hope to attract the attention of the consumer.
To conclude, there are a few immediate benefits of diesel price deregulation, but the real challenge and the benefit for the government will only come, once oil prices start to go up again.

The article originally appeared on www.FirstBiz.com on Oct 20, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)