Free market supporters claim that markets are largely self-organising and self-regulating, and governments should step in only when there is a market failure. They talk about the disciplining powers of the financial markets in facilitating efficient intermediation from savers to borrowers.
Take three recent examples of economic sectors from India which are fairly deregulated and which are very competitive - airlines, telecommunications, and renewables. All the three have witnessed very strong market growth and have had long durations of cheap and plentiful credit inflows. All three have been characterised by very aggressive competition, leading to ultra-low tariffs and prices. The problem is that all the three sectors and their creditors are today entrapped in a bad equilibrium, struggling to clean up the mess and restore profitability.
In all the three cases, the much vaunted dynamics of the market mechanism went missing. Businesses invested or bid without concern for sustainability, outbid each other to lower prices without regard for margins, and lenders recklessly opened up their credit taps.
Livemint reports that the aviation sector may be following the telecoms and renewables sectors into a crisis. Even the opportunity presented by the collapse of Jet Airways (the reduction of supply and attendant boost to pricing power) has not helped. Sample this,
In their quest to capture the capacity vacuum left by Jet Airways, airlines had cut fares and added capacity, but nearly every incumbent is now facing a profit squeeze. They had also bet on ordering the latest and most fuel-efficient engines and aircraft to squeeze out a profit wherever they could. But that strategy appears to have spectacularly backfired... Indian airlines are expected to lose over $600 million in FY20 as compared to a previous estimate of a full-year profit of $500-700 million, consultancy Centre for Asia Pacific Aviation (CAPA) India said in a recent report. The cash position of the industry remains under pressure, with corresponding risks. Most airlines other than IndiGo are precariously placed, with cash balances available—in some cases—to cover only a few days or weeks of expenses, it added... With no airline willing to raise fares, ballooning costs mean that the sector has entered into a worrying unsustainable cycle, prompting aviation minister Hardeep Singh Puri to warn industry participants to stop “predatory pricing".
This is a telling point about the so-called market discipline,
“We are all held captive to the actions of the stupidest competitors, whoever they may be on a given day. They set the price and other airlines have no option but to follow," said a third senior airline executive on condition of anonymity. “This has been causing a lot of financial distress in the sector." “All it takes is one discount, and the entire pricing discipline collapses like a pack of cards," said the executive. “And, of late, the pricing discipline in the period of a week to a fortnight before departure has vanished." Previously, this booking period was considered a prime time slot where discounts offered would be minimal, but the country’s sluggish economy has prompted airlines to offer lower fares, said the second airline official mentioned above. “This is not a feasible model. Casualties in terms of closure of airlines are bound to happen," the executive added.
Any sudden increase in oil prices could be a body blow to the sector.
In all three sectors, the competitive market mechanism and disciplining powers of finance could not prevent reckless investment decisions. Further, not only could it not help the market arrive at sustainable pricing (the so-called Econ 101-speak, "market clearing" price), market competition actually forced the sellers into a destructive race to the bottom with pricing.
Not to mention, this is only the latest example of such bad outcomes in the same three and other sectors, arising from unbridled market competition.
None of this should be a reason to junk the market mechanism, which for all its flaws is superior to its alternatives, but be aware of its serious limitations. It is a cautionary note against the typical blind and naive faith that supporters exhibit.
This is also not an argument for direct price regulation by a public agency. It is about being nuanced with resource allocation decisions (as against the blind faith in auctions), encouraging industry-wide principles of restraint and safeguards against race to the bottom, regulators being even-handed in protecting interests of both consumers and providers, carefully calibrating and phasing reforms (the removal of interconnect charges in telecoms), vigilance on sectoral credit flows and exposures.
It is a reminder about the important role of the state. One, there are several major areas where state has to be the dominant provider - education at all levels, primary and secondary health, many infrastructure services. There is no country in the world which has ever developed by following the market-will-deliver approach in these areas. Two, there is the role of state in creating the market itself and constantly monitoring to keep markets honest (and not merely stepping in where market fails) - finance is the best example. It is now widely acknowledged by even those on the right (except those ideologically blind and evidence-immune kinds) that financial markets have to be regulated. Fairly active regulation is necessary to create and sustain the market itself, and not merely address market failures. This is true of many sectors, including wherever private sector delivers infrastructure services.
The argument that government is anyways doing things badly, so why not deregulate and let markets do the job is alluring. But it can end up doing more harm and entrap the system in even worse equilibrium from which getting out is really hard. For example, since public health care system has broken down, we are chasing the market God of health insurance (with strategic purchasing etc), and in the process neglecting primary and secondary care, thereby worsening the problem. Or, since public schools are delivering abysmal outcomes, we are talking about vouchers and private schools, little realising that our experience with private education is even worse (witness the mess that privately run professional colleges and market competition has ended up creating).
In the context of increased private participation (public provisioning of privately produced goods and services), two things assume importance. One, markets and private participation demand regulation and contract management, which becomes daunting challenges for a weakly capacitated state. The attendant capture and corruption is likely to leave us with an even worse equilibrium than now. Second, Indian capitalism, at all levels, is still deeply infused with a corrosive culture of cutting corners, cronyism, and rent-seeking. This makes abuse of the market mechanism and contracts a most likely scenario.
No comments:
Post a Comment