Want to fix price rise? Let them hoard!

Narendra Modi and his ministers are insisting that the current problem of high prices for specific agricultural products is due to speculative hoarding and not due to supply shortages^{1 2}. Given the assumption of hoarding being the source of the problem, the solution presents itself naturally and effortlessly. If hoarding is the problem, stopping hoarding is the obvious solution!

This ‘smart’ solution was identified way back in 1955 by Pandit Nehru and his ministers. Befitting a ‘well intentioned’ government, they gifted to India the Essential Commodities Act. The government using the Essential Commodities Act, acquired powers to prevent hoarding, among other things for the ‘public good’.

Roughly 60 years since the ‘solution’ to the problem was implemented, we still have the same problem with undiminished severity! Maybe the implementation was not good enough! But could an entirely different idea be true? Could it be that the implemented ‘solution’ is the reason why the problem has not been solved in 60 years! Let’s get back to the drawing board.

How the Essential Commodities Act inhibits investment in agriculture

Once upon a time there was this lad who had a brilliant idea on how to conserve rain water so that agriculture will not suffer much, even during years of less rainfall. He was overjoyed and quite justifiably so. More than being a mere scientifically brilliant idea, this idea had the power to change the lives of the poor in the country who are worst hit when the vagaries of nature prevent them from satisfying one of the most basic needs of all – food.

But he needed money to implement his idea. The farmers he would work with, did not have the money. As anyone would do in this situation, he approached some investors who might be willing to help him with the idea. All the banks and investors he approached appreciated him for his brilliant idea. And then they asked him what his business model would be for making money. The answer was obvious. Even during years of low rainfall, we could produce onions or what you will. And that will give us profits.

But then one of the investors pointed out a flaw in the plan. If you are able to produce lots of onions in a year when the prices have risen due to low rainfall, the ‘well-intentioned’ government will use Essential Commodities Act and take away your holdings. So the plan turned out to be not as profitable as the other options the investors had. The next day the investors bought an IPL team coz the government would not interfere, however immense their profits margins might be.

The investments which could have gone into agriculture went into cricket.

See I told ya, the greed of the investors is the problem!

Once upon a time there was a boy whose toy fell off the table and broke to pieces. He thought for a while and concluded that the gravity of the earth was the problem which caused his toy to fall towards the ground and break into pieces. He decided that preventing the gravity of the earth from acting on the toys was the solution he had to implement to ensure longevity of his toys.

Someone tried explaining to him: You should try to find a solution which takes into account that the gravity of the earth does exist in the real world. But not everything is affected by gravity, I have seen airplanes, helicopters and hydrogen balloons move away from the earth, he dissented. You see that happening because gravity acts on the air surrounding these, people tried to explain to him. Gravity can at times manifest itself in things moving away from the earth, people tried to reason.

All this talk didn’t cut any ice with him. He grew up to become a socialist. He then used tax money to try to solve problems by implementing solutions which assumed gravity did not exist. When the solutions didn’t work out, he concluded that they had not spent enough money on the solution and went on to spend more tax money.

But the government can invest in agriculture

‘Sure I agree that the investors are greedy and it’s not possible to eliminate greed completely. But that does not imply that the Essential Commodity Act is bad in itself. We can still have the law because it can prevent hoarding and the government can invest in the young lad’s idea to conserve rain water. This will be the best of all possible worlds, we have investment in agriculture and we also prevent hoarding, this is the mixed economy which draws the best of both capitalism and socialism. The government does not have the profit motive like the investors; it thinks about the ‘public good’ and hence is a perfect fit.’

Ok, sure. Let’s sum up the allocations in Indian government’s budgets for agriculture since 1950 till 2014. How much tax money has been spent on agriculture since independence? Why has it not helped Indian agriculture? Why do we still not have perennial, monsoon independent irrigation facilities?

Let me add another question. Why do we see this pattern of humongous outlays with zilch outcomes in most government plans?

The reason is precisely that attribute of government, which somehow the socialist concludes, makes the government fit for such ventures – the absence of the profit motive. More on the specifics will be deviating from the central issue of this post.

How Essential Commodities Act drives honest traders out of the market

Socialist governmental action generally makes the honest poorer and the dishonest richer. Let’s see how it plays out with the ECA.

What is the effect of the ECA on the honest trader? The honest trader by definition follows the law even without the police knocking on his door. So given the ECA exists, the honest trader will not hoard any commodity declared essential by the government.

What does the dishonest trader do? By definition, he will continue to hoard essential stuff as compared to the honest trader. The police cannot reach every nook and corner, that’s how the real world works! Since the honest traders are not hoarding, the monopoly of the dishonest traders over the essential commodity is strengthened.

What is the final outcome of this game? The dishonest traders emerge richer due to his monopoly over selling at the higher price. Yes, some dishonest traders get caught but not all. The honest trader did not become much richer during this game. With repetitions of this game every few years, the honest traders are driven out of the market and the dishonest strengthen their monopoly. The ratio of dishonest traders among traders increases. The socialist concludes that the profit motive is the cause of dishonesty and tries to find a solution which works by suppressing the profit motive.

Now is also the time when the socialist lectures to the free marketer about the dangers of monopolies and how more government rules are necessary to tackle this menace! He explains how in the real world markets are not perfect, afflicted with monopolies, unequal bargaining power, informational asymmetry, price and wage stickiness and why the government much intervene to restore a semblance of the socialist’s textbook version of the ‘perfect’ market. When questioned as to how his policies are helping make the market more efficient, he explains that it’s too complicated to explain and ‘good intentions’ and heart wrenching speeches are what you should look for and be satisfied with!

Why India does not see a steep price rise of Coca Cola but does see that for onions

Impose Essential Commodities Act on Coca Cola and see the ‘tamasha’ play out!

Right now when traders expect a demand surge for Coca cola in any part of the country, for whatever reasons, Coca Cola trucks rush towards that area. All traders, honest and dishonest alike, invest money to hoard Coca Cola in that area and since there are so many competitors vying for that business, except for slight increase in prices , they primarily profit by increasing volume coz raising prices is not that viable an option due to intense competition.

The market transmits the price signal from the traders to the Coca Cola Company. The most advanced algorithms and data mining techniques run on the best available hardware in the world to predict demand patterns throughout the country for Coca Cola. The most scientifically advanced water filtration and storage techniques are employed by Coca Cola to ensure an uninterrupted supply of cola to the population. When was the last time you heard that the drought caused a scarcity and associated price rise for Coca Cola?

We could have had this model running for onions but sadly the government tried to help!

Citiations

1. Ketki Angre and Sharad Sharma, “
   Price Rise: Government Cracks Down on Hoarders, Will Sell Onions at Wholesale Rates” NDTV, July 2 2014, accessed July 30 2014 http://www.ndtv.com/article/india/price-rise-government-cracks-down-on-hoarders-will-sell-onions-at-wholesale-rates-551347
   
2. BS Reporter, “
   Govt moves to rein in onion, potato prices” Business Standard, July 30 2014, accessed July 30 2014 http://www.business-standard.com/article/economy-policy/govt-moves-to-rein-in-onion-potato-prices-114070300114_1.html