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Vision 2020 -- Economics' heart must be in right place

Unless designs of year 2000 are planned to meet the requirements of year 2020 or even 2100, we will be confronted with avoidable bottlenecks. All bottlenecks make the rich richer and the poor poorer. So, if our policy-makers love the poor, they should ke ep production constantly ahead of demand, whatever that demand may be, says P. V. Indiresan

This is the 20th article in the Vision 2020 series. The previous one was published on May 22.

ANY SUBSIDY, either for the consumer or for the producer, is followed by scarcity. When the subsidy is for the consumer, profits are squeezed. There is little incentive to grow or maintain quality. The result is scarcity.

When the subsidy is for the producer, production is limited by the amount of subsidy. The result is, again scarcity.

Our governments, both at the Centre and in the states, have become subsidy addicts, making ours a scarcity economy. In this lose-lose situation, the government is bankrupt, production stunted and consumers are short-changed. How can we get out of this tr ap? A look into the concept of consumers' surplus can probably help.

The market price is the highest the seller can get, and the lowest the buyer will pay. During scarcity, rich people will be ready to buy up such scarce goods by paying a price p(r) higher than the normal price p(m). In other words, in normal times, the r ich get the same goods at a lesser price than what they would be willing to pay in times of scarcity. The difference p(r) - p(m) is the extra disposable income in their hands. This is known as Consumers' Surplus. An important facet of this concept is tha t `The richer the consumer, the larger the p(r) - p(m).' Therefore, the Consumer Surplus benefits the rich more than the poor. So it will be an act of social justice if the Consumers' Surplus is minimised as far as possible.

The supply situation operates in a complimentary fashion. When the market is slack, the seller will charge a lower price _ lower than the normal market price. The difference between the market price and the price the seller would have charged when custom ers are scarce, is the profit for the supplier. This is known as Producers' Surplus. This makes it possible for the producer to invest more and, thereby, produce more. It also offers the producer an incentive to do so. So, it is in the interest of societ y to make the Producers' Surplus as high as possible. In other words, as much of the Consumers' Surplus as is feasible should be transferred to the Producers' Surplus.

This can be done the way devotees are handled in Tirupati temple. Poor devotees are given free darshan, but have to wait long hours in the queue. Those who can afford to pay are taken in a shorter queue. But the two queues merge at the sanctorum. And, th ey all get the same few seconds' darshan. So, the ultimate product for both the rich and the poor is the same, except that the product has been differentiated into two types _ one of the long queue and one of the short queue. In the bargain, some money h as been extracted from the rich and transferred into the hands of the producer. That is how the temple provides services which would have been otherwise impossible. That is a win-win game. The rich benefit by standing in a shorter queue. The poor, too, benefit from the free darshan.

It can be shown that the larger the number of levels of product differentiation, the smaller the Consumers' Surplus and higher the Producers' Surplus. The Railways offers several classes of travel. All passengers travel at the same times, but some pay mo re to travel comfortably, but not any faster. That is good for a start but not good enough. The Railways' pricing policy is not correctly designed; it does not extract from rich passengers as much of their Consumers' Surplus as it should.

In contrast, airlines in the United States are past masters in this art. They have rates to suit every purse. All passengers fly the same plane, and even in the same class. But the conditions of purchase are different, some more convenient than others. S o, everybody pays for the best convenience they seek. In that manner, virtually, the entire Consumers' Surplus is thus gathered by the producer! So, the producer has the wherewithal to invest more and the incentive, too, to do so. Growth becomes maximum ; the consumer has the largest variety to choose from and scarcity becomes minimum, if not non-existent.

As a general rule, the marginal price of a product follows a U-shaped curve. Initially, the marginal price is high because significant capital additions will be required to initiate supply. Once the system is in place, additional costs are few and the ma rginal price becomes lower than the average price. However, when demand increases to such a level that it exceeds production capacity, scarcity conditions take over; and prices shoot up once more. So, there is one region in the middle where the marginal prices are low. The dip is greatest in the case of capital-intensive projects.

If the producer is operating in the dip of the U-curve, it will benefit the poor substantially if they are charged the low marginal price. However, that can be sustained only when someone has bought enough at the higher initial cost and helped amortise c apital costs. It goes without saying that this can operate only when supply is in excess of demand. For instance, if a train has empty seats, cheap fares can be offered to those who are willing to take the chance of getting in at the last moment. That sm all income is better than having no income at all. That is a win-win game. The poor get cheap seats; the producer gets some income which is better than no income at all.

In this connection, four precautions are:

AThe rich must have the first refusal. Only what is left over after the rich are fully satisfied can the goods be offered to the poor;

AThe rich must pay the full cost and the poor a charge not less than the marginal cost (in exceptional cases, free service may be provided, but the cost should be borne by the producer and not by the state. The Tirupati temple is a good example);

AProduction must be maintained under conditions of minimum marginal cost. Hence, growth must keep in pace with demand and conditions of scarcity should not be allowed to develop; and

AIn some form or other, the reduced price must be paid for in kind (for example, the longer queue in the case of the Tirupati temple).

The last one is a crucial point. Without such a stipulation, the demand for lower price will go out of control and push the system into the region of scarcity and high costs and prices.

Let us apply these principles to the case of electricity supply, where the problem has become uncontrollable. Free electricity may be confined to the hours when there is excess capacity, between 1 a.m. and 5 a.m., and that too forpumpsets only. Farmers then get a benefit, but at the cost of some discomfort. At the other end, high-tension consumers may be guaranteed high quality power, but only by paying a fairly stiff tariff. There could be a third tariff for domestic consumers, but t he supply will be available only when there is power to spare after the demand of high-tension consumers has been met in full.

Unanticipated problems, too, can cause unbearable misery. As the economy progresses, new kinds of demand will emerge. Unless the system is designed to accommodate such a change, scarcity conditions may erupt and the system may collapse. For instance, all along, houses have been built on the assumption that there will be few vehicles. Now, the situation has changed. More people are buying two-wheelers and cars.

Unfortunately, neither the houses nor the roads have been designed to accommodate that change. In hindsight, there has been no vision. As Nehru used to say, do not plan as if we will be poor forever!

The demands on our economy, on infrastructure and on the services, will inevitably be different (not merely larger) in the future from what they are today. What they will be cannot be conceived by marginal thinking, or by making incremental additions her e and there. Unless designs of year 2000 are planned to meet the requirements of year 2020 or even 2100, we will be confronted with avoidable bottlenecks. All bottlenecks make the rich richer and the poor poorer.

So, if our policy-makers love the poor, they should keep production constantly ahead of demand, whatever that demand may be. Only then will it become possible to help the poor by letting them have the leftovers from the tables of the rich at an affordabl e price. If that sounds distasteful, the alternative is worse! No doubt, economics needs a heart. But it must be in exactly the right place, not too much to the Left, nor too far to the Right.

(The author is former Director, IIT, Chennai.)