Indian Express, 28 November 2005
Parts of the oil economy are criminalised because fuel prices are not market-determined. The profits make murder an acceptable risk for entreprenurial thugs
The responsibility for the murder of IOC officer S. Manjunath lies with economic policy. The murder is a wake-up call for the government to change policies in the petroleum sector. The government’s decision to continue with the policy of subsidising kerosene, despite knowing fully well that kerosene is being used for widespread adulteration of diesel, is irresponsible and callous.
It is well understood that the structure of economic incentives is a far stronger force than policing. It is easy to blame the law and order situation for the murder. But the real blame lies with the petroleum price policy that created incentives for adulteration. When diesel costs Rs 35 per litre and kerosene is available in PDS shops for Rs 11 per litre, there is a very powerful incentive for petrol pump owners to adulterate diesel with kerosene. If a mafia has arisen, it is a creation of government policy. In the same way that the smuggler gangs of the 70s were the inevitable consequence of restrictions on imports, the mafia that murdered S. Manjunath is the by-product of the pricing distortions in the petroleum sector.
The policy of providing subsidy to kerosene is supposed to be about helping poor people. But for a long time, there has been ample evidence that a tiny percentage of the subsidy on kerosene reaches the poor.
When the Administered Price Mechanism (APM) for petroleum product prices was dismantled in April 2002, it was hoped that these prices would move freely as they do all over the world. They would stop being determined by political considerations. More importantly, it was hoped that free imports and distribution would lead to competition, so that helpless consumers would not be in the clutches of the ministry of petroleum. Instead of moving forward with the agenda of competition and decontrol, we have stayed with the monopoly of the government and continued political interference.
The problem is not limited to kerosene. The bad economic policy of the oil sector has hit LPG as well. LPG prices are subsidised, again in the name of the poor, though poor people definitely do not use LPG. The subsidised LPG gets diverted to commercial use. People respond to incentives, so the larger is the subsidy, the larger is LPG demand.
The government does not have the grace to place the subsidy cost on budget. Oil companies are being forced to absorb losses arising from the low price of LPG that’s set by the government. So they have an incentive to cut production of the subsidised product. If need be, oil companies will make all kinds of excuses about factories that have stopped working, in order to avoid selling goods at a loss.
So, we have a shortage of LPG cylinders. For the last two months, gas companies are not giving new connections. A visit to an HPCL outlet is like deja vu, all over again, where an Indian consumer is a supplicant at a store and is told that the monopoly will refuse to sell to him.
True to the 1970s India, Mani Shankar Aiyar is very engaged with the LPG shortage. He promised that the LPG shortage would`1111` be sorted out in time for Diwali. He is trying to send the police after black marketeers. He should learn a lesson or two from Manmohan Singh and P. Chidambaram, who conquered gold smugglers by removing controls, not by sending in the police.
Meddling in the market by trying to control the quantities demanded and supplied, instead of relying on the price mechanism to clear the market, has been tried in the 70s and failed abysmally. The economic illiteracy of policy that set out with the dubious goal of giving LPG and kerosene consumers a subsidy has instead given shortages, criminal activities, and the murder of one ethical citizen. The dismantling of the APM failed in the NDA’s term, when on the eve of the Allahabad elections the then petroleum minister Ram Naik resumed interfering in petrol prices. The core rot of the petroleum sector is that of violating the principle of competition. If the private sector could freely import petroleum products and sell directly to consumers — if this economic freedom was unquestioned — then the shenanigans of the ministry of oil would be greatly curtailed. But the oil ministry continues with its monopolistic control over import and distribution of oil. That sets the stage for unethical or ignorant ministers for misusing the system. Whether it’s Ram Naik’s attempt at manipulating elections, or the petrol pump allocation scam unearthed by The Indian Express, or Manjunath’s murder — these are all the consequence of the control-raj.
What is the solution?
Oil policy in India requires to shift away from the interests of socialists, the interests of oil PSUs and the interests of oil companies like Reliance. Instead, we need to apply the first principles of a market economy. Better health of oil companies requires the sector must be exposed to competition. At present, a host of barriers make it difficult for the private sector to import and sell petroleum products in the country. In the 1990s, India found its way out of a mess in the industrial sector — where there were thousands of incompetent companies — by cutting customs duties and opening up to imports. The same story applies in the petroleum sector. We should focus on opening up the Indian market for petroleum products to global competition. Anyone should be allowed to open petrol pumps, buy petrol from anywhere in the world and sell to customers. Each of these steps should be jealously protected from the meddling of the ministry of oil and it`s cronies in the oil sector. This will help destroy the monopoly of oil companies and force them to work in a competitive framework.
One concern is this will lead to a rise in oil prices when world oil prices go up as the government will no longer be able to “protect” consumers. But should scarce public resources be wasted in shielding the rich Indian consumer from the ups and downs of world prices? While all agree that low inflation is a desirable objective, is it desirable to achieve low inflation by artificially keeping the price of oil products low? If world oil prices rise, the economy needs to adjust itself to higher prices. A policy of having subsidies requires taking public resources away from producing public goods. It also reduces the adaptations of the private sector such as increased energy efficiency, and shifting to non-oil sources including renewables.
The short-run price elasticity of oil, the amount by which consumption of oil changes in the short run when its price changes, has usually been observed to be low. Given technology in use, consumers can reduce the consumption of oil by making some behavioural changes. However, the long run price elasticity of oil is high. Over the long run, a higher price of oil creates incentives for adoption and development of technology which is not intensive in its use of oil. Either the use of alternative sources of energy becomes more profitable, or companies invest in fuel efficient technologies. This has been seen in the automobile industry in which significant R&D went into the development of small fuel efficient cars and when consumers all over the world were seen preferring more efficient cars.
Policy in the oil sector has been mismanaged over the years. Manjunath may have been the first to be murdered, but if the government does not sort out the mess it has created, it will be signing the death warrants of many more young and honest officers in the public sector.