Wednesday, May 23, 2007

Artificially Scarce Goods

Goods and services are classified based on two characteristics - excludability and rivalness in consumption. A good or service is excludable if the supplier can prevent those who do not pay from consuming it, while non-excludable goods cannot be prevented from being consumed by anyone. A good or service is rival in consumption if the same unit cannot be consumed by more than one person at a time, non-rival if it can be consumed by many simultaneously. Non-rival goods therefore have the unique characteristic that the additional cost of adding one more consumer is . Private goods are the only goods and services that can be efficiently produced and consumed in a competitive market.

All private goods are obviously excludable and rival in consumption, whereas all public goods are non-excludable and non-rival in consumption. I am interested in the category of goods and services which is excludable and non-rival in consumption. These goods and services are called "artificially scarce goods". Though the marginal cost of allowing an additional consumer for such such goods and services is zero, they are always supplied at a cost to the consumer (probably to recover atleast part of the initial investment costs). These goods and services however suffer from difficulty in fixing their prices, due to which they are plagued by a problem of inefficiently low level of consumption. The most common text book examples of such goods are computer software and pay-per-view television.

Access to water and sewerage distribution networks, and by implication acccess to water supply and sewerage services, are also examples of excludable and non-rival services. These services are delivered through distribution networks, laid along road margins. The individual households take their connections by payment of some fixed connection charges to the utility service provider. They also pay a monthly tariff as consumption charges for the service.

However, there is one thing about these services that strike me as interesting and unfortunate. It is the inability of a large proportion of people to access these services, despite the presence of the distribution network in front of their homes. The connection charges necessary to gain access to a water connection, limits the uncontrolled access to these distribution networks. All the households in a street use the same distribution line to gain access to water connections. Once the network is laid, the marginal cost of any new connection is zero. However, the marginal returns are equal to the monthly water tariffs.

Connection charges are undoubtedly necessary to help regulate access to these services and ensure its long-term sustainability. But by restricting access, we are creating an economically inefficient outcome, both in terms of sub-optimal utilization of an infrastructure asset and also foregoing the monthly tariff revenue stream. Besides, we are also denying citizens access to basic civic services.

There are those who argue that by lowering access charges, we are foregoing a substantial one-time connection charge revenues. I am not even remotely going to dispute that this revenue is indeed susbtantial, but it will be revenue only if it is realised! And I have serious reservations about what portion of this unrealised amount can be collected, especially in the not so well off areas of the City. Experience shows us that in such areas once a utility network line is laid, on an average nearly half the population take connections immediately, while another 10-20% take connections within a few months, while the rest continue to refrain from accessing the service. The inefficiently low level of consumption therefore get frozen. In fact there are numerous streets in Vijayawada where a significant proportion of residents have not taken connection even years after the line was laid, due to prohibitive connection charges.

In fact, a significant portion of them access the service through illegal connections, public taps, technological spill overs etc. It has been found across all our cities that it is very difficult or even impossible to control these factors beyond a point. We therefore need to lure this residual category of consumers into leagally accessing the service. The challenge is to do this without distorting the incentive structure for the others. Have we not seen this before? Cell phone companies routinely offer many connection packages, some with lower access charges. This is done to capture certain categories of consumers who otherwise would not have taken the connections, thereby resulting in sub-optimal utilization of the network and loss of potential revenues. The central fact remains that we cannot expect the residual consumers to take connections with the prevailing connection charges. The problem we need to address is how much to lower and when.

Access to some of these services can and should be subsidised for certain category of consumers. A differential access charges policy can be introduced and the subsidy can directly cover the revenue foregone by the service provider. This would atleast bring the system to an efficient level of asset utilization, besides adding to the monthly revenue stream, and all this without any additional cost. To sceptics who doubt the ability of these residual consumers to pay even the monthly tariff charges, my contention is that most of these services are very reasonably priced and are even subsidised for certain categories of consumers. For example, the monthly water tariffs in Vijayawada is Rs 40 for the Below Poverty Line (BPL) households, while it is Rs 80 for the others.

All the other utility services - electricity, telephone, cable TV - suffer from this problem. All of them are examples of economically inefficient systems and are provided by both Government and private service providers. It may be appropriate for the governments and private service providers to have a re-look at how access to these civic services can be increased to its optimal level. Further, as we have already seen, eliminating or reducing bariers to access can be a helpful policy tool in even containing pilferage of these services.

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