Saturday, September 29, 2007

Why the 1 lakh car is not smart economics?

There has been a lot of debate about the impending arrival of a Rs 1 lakh car. The Tatas have been at the forefront of this little Indian contribution to the world of automobiles. I have very serious reservations about its launch. Here is why.

It is true that that a Rs 1 lakh car will help fulfill the aspirations of millions of Indians to own (and the hopes of car makers to be able to sell) a personal car. This will immediately create a massive market for cars, by some estimates nearly 100 million, and even bigger than the existing market for all categories of cars. It therefore makes great business sense for car makers to jump into the Rs 1 lakh car bandwagon. While the individual utilities of both parties to the transaction - the buyer and the seller - are surely enhanced, the sale imposes serious costs on everybody else. In other words, a sale of Rs 1 lakh car generates a negative externality.

What are the negative externalities generated by the Rs 1 lakh car? The main customer base for the Rs 1 lakh car will be those presently using two weheelers. They will be encouraged to swap their more fuel efficient two wheelers for the status conferring, but more fuel consuming cars. This straight away translates into more petrol and diesel consumption, with all its well documented environmental consequences. Greater demand for a scarce resource like petrol or diesel, we all know, generally results in higher prices. Four wheelers occupy much more traffic space, and is a recipe for exacerbating our already chronic urban traffic and parking problems. There will be more and longer traffic congestions, and average speeds in our cities will fall further. With higher travel times and greater difficulty in finding parking space, the opportunity cost of using a car will become higher than the benefits of using it.

That is not all. Taking a more macro-view, it will severely affect the two wheeler market. The two wheeler sellers and their suppliers will suffer the consequences of a fall in demand. There is another scenarion possible. The fall in demand could lead to producers lowering two wheeler prices, thereby bringing more customers into the net. This could theoretically increase sales of two wheelers. So ironically enough, we could end up with a much bigger environmental and traffic problem of more cars and more two wheelers on our roads.

Even for the car industry, this may not be a step in the right direction. Ideally any industry ought to be moving up the value chain, so as to increase profit margins. This means the car manufacturers should be trying to wean customers away from the cheaper and basic models, to the medium and higher end ones. The transition from Maruti 800 to the Matiz's, Santros and Zens, was in keeping with this expectation. But a Rs 1 lakh car will in all probability generate a race to the bottom, and could end up cannibalizing significant portions of the hitherto lower and lower-middle segments of the car market. A customer for a basic Maruti could gravitate towards the Rs 1 lakh model. Profit margins will be adversely affected, and the industry could face a crisis.

Here is Tom Friedman endorsing the anti-small car club, in an NYT article, No, No, No, Don't follow us


Anonymous said...


And the only benefit of switching to a car is status? In India's sweltering heat?

Also who is more accident prone? Who is more likely to die in crashes?

Urbanomics said...

Thanks rohit. Yes, I agree that cars are less accident prone than two-wheelers, and also that cars are status symbols. Yes, cars may be a better health option than two wheelers, given the sweltering heat?

But I did not posit a choice and judgement between cars and two wheelers. The soltution to this and most other urban transport related problems is simple - good, affordable public transport. Instead of weaning away people from their cars and two wheelers, a Rs 1 lakh car would only encourage furhter movement away from public transport, and towards private transport. This is clearly not desirable.

In any case, public transport is less accident prone, more healthy, and best for the sweltering heat.