Tuesday, August 6, 2013



Any new approach must correct the incentives for productivity and create disincentives for corruption.  It has long been said that Democracy is the worst form of government except all the others. The greatest advantage of a market economy is that it is based on the most realistic assumption that every individual will act in his/her best interest.  Economic theory also tells us that under certain conditions market competition produces results that are the most efficient.   As the obverse of monopoly it is a useful goal even when the ideal is not attainable. It has therefore come to be widely accepted over the last two decades that market incentives are the most sustainable incentives for business, workers and farmers and that market competition is the best handmaiden of the social purpose. The best antidote to exploitation by corrupt businessmen & bureaucrats, lazy organised sector workers and shoddy products and services is competition.
Competition is also the best means of dispersing economic power.[1]  In an ideal system (Schumpeterian) competition would ensure that wealth could only be garnered through innovation, acquisition of special skills, hard work and thrift.  Such wealth generation is therefore in the interests of the entire society.  Monopoly (or oligopoly) is the anti-thesis of such competition as it allows generation of profits without any such meritorious activity.  Government created monopolies, whether deliberately created or the indirect result of distorting policies, are the worst culprits in this regard.  ‘Natural’ monopolies have to be regulated to ensure that ‘monopoly profits’ are minimised. 
Ideal competition is just that and market incentives are not perfect.  There will be market failure and non-existence of markets.  Market economics itself help identify, analyse and suggest the best way of dealing with such problems; Appropriate policies, developmental actions and regulatory institutions.
The second underlying problem can only be addressed by the dispersal of the government’s enormous power.  This requires right sizing of government, shedding of activities that can be performed by others, decentralisation of governmental functions to lower levels based on the principle of subsidiarity, the creation of countervailing power, transfer of regulatory functions to independent professional regulators, empowerment of citizens and civic groups, giving voice to the under-employed and creation of checks and balances.

Incentives Efficiency & Productivity

Law & Incentives

            Laws, particularly economic laws (including contract law), do not merely define what a citizen/resident can or cannot do.  They create a system of incentives and dis-incentives for economic agents and those charged with implementing the law.  Most economic laws have had consequences that the originators had no inkling off.  The common result of the myriad such laws are to create incentives for rent seeking, rent creation, bribery and corruption.  The rules & procedures for public institutions, such as universities, research institutions, and hospitals, are equally oppressive.
Recent studies have demonstrated the (static) costs imposed on producers by the bureaucratic red tape and harassment that results from oppressive rules and procedures.  The dynamic costs, in terms of discouragement of creative, innovative & knowledgeable people from entering business, though much harder to measure may be more devastating in the long run. It is necessary to systematically audit all economic laws from the incentive perspective and modernise them keeping in mind the results that they have produced.  Laws, rules and procedures must be modified to minimise the time & money cost of compliance to relatively honest economic agents.
Labour laws, though made with the best intentions have in many instances had the opposite of the intended affect.  Labour laws that focus on health and safety of the workers are essential and should be extended to unorganised workers.  Similarly the right of assembly, formation of labour and right to strike are democratic rights of workers.  Harmful laws are those that try to overturn market demand, supply and pricing principles, such as elements of the contract labour act Industrial development and regulation act and the Industrial disputes act.  These elements of laws by protecting existing organised sector workers provide an incentive for them not to work sincerely & efficiently and also provide a dis-incentive to hire new workers.  They need to be made more flexible so that organised labour-intensive manufacturing & services are encouraged to generate higher productivity jobs.

Competition & Efficiency

The same basic principles of competition apply to infrastructure services and factor markets as to the goods market.  De-control and de-licensing must be completed in the remaining items such as drugs, fertilisers, coal, petroleum, sugar and small industry. SSI reservation is perhaps one of two main reasons why India, unlike China, has not become the ‘manufacturing base’ for the world supply of labour intensive goods.  Lacs of new jobs have been lost in exportable industries in a futile attempt to preserve the profits of existing small-scale industrialists.
Similarly the key issue for a sick consumer is whether the drug is genuine and will cure the sickness that it claims do, or whether it is one of the myriads of spurious drugs that are flooding the market.  The price is a secondary consideration, and the governments health programs are the appropriate channels for insuring that poor patients have access to basic drugs at an affordable price.   
De-control and de-licensing must also be extended to services, including infrastructure services (e.g. telecom) and factor markets (labour & management).  Contrary to some assertions, the same principles apply to infrastructure service, with the addition of measures to unbundled and regulate natural monopoly segments.

State Monopolies

State monopolies, whether they are departmental public enterprises or Public sector units, have proved to be as inefficient and antithetical to consumers/public interest as private monopolies.  Such monopolies not only invite extraction of monopoly rents and X-inefficiency but also confer additional power on government departments & their ministers that is easy to misuse.  Introduction of competition and dispersal of this power requires, free private entry, un-bundling of all natural monopoly elements and their regulation by independent regulators, and privatisation of all contestable elements (core & non-core) so as to introduce genuine competition into the latter. Public sector & nationalised banks also constitute a near-monopoly as around 80% of the entire banking system is owned by the government.  This is the highest percentage in the world.  As we already have one of the better regulatory systems (RBI) and banking has no natural monopoly elements, the banking system will only become competitive if these are privatised.

Extract from, "A New Development Paradigm: Employment, Entitlement and Empowerment,"  Economic and Political Weekly, Vol.XXXVII No. 22, June 1-7, 2002 [ NewParadigm4nf ]

[1] A credible “Threat of competition,” for instance through potential imports, is an even more powerful incentive for change than actual competition/imports.

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