Pricing is key in India

by Hansi Mehrotra

18th July 2016

Akhilesh Tilotia’s Making of India basically attempts to answer this question by taking an in-depth look at the social, political and economic transformations we are witnessing in India today. This series of articles, based on some presentations, summarise the key themes of the book.

Part 2 – Pricing is the key

A key element is the fraught relationship that India has had with a critical economic variable: prices. Prices, whether hidden or visible, have shaped our society, economy, demography and urbanization. However India has tried to muzzle it sometimes, it has paid heed to it many a times but mostly, it has been flummoxed and surprised by the discovery of price and the impact it has on economic or social outcome.

Think, for example, of water and sewage or public transport in urban India: in both cases, as in the case of many other utilities like power, the pricing of the service of the utility is kept very low. The outcome is that city utilities do not generate enough resources to invest in creating the required infrastructure. People then get either completely excluded from the services of the utilities or get the outputs rationed. The rich (or the relatively-better off) are able to create a parallel infrastructure for themselves at a significant private cost (think of water tankers or two- and four-wheelers) while the poor remain dependent on poor quality services that utilities provide (water available only for a few hours a day or over-crowded buses and trains) and the handouts that politicians can arrange for them.

Where low prices have failed

This story plays out in sector after sector: education (costly private schools for those who can afford and a right to education for those who cannot), food (private grain market for those can buy; a poor quality public distribution system for those who cannot) and health (pricey hospitals and doctor care for those who can afford; a less-than-optimum health care for those who cannot). The point of discussion here is not whether the utilities of water, education, power, food, etc. should be in private hands or public: India has had a troubled experience in trying to make public-private partnerships work. The point here is that utilities (like any economic participants) require funds and effective governance to offer good quality services.

The private cost that this public failure imposes on private citizens is detrimental to India on two counts: (1) the cost being high (as the creation of parallel infrastructure denies it the scale benefits to reduce costs) forces the spending of a large part of the India’s wallet on basic necessities keeping Indians tethered to a lower quality life and (2) the public failure hits the poor and the vulnerable the hardest. The failure of public utilities is hence not an option for India. Public utilities (i.e. utilities run for general public purposes and not necessarily run by the public sector) have to be effective and efficient competitors to private alternatives. For example, a metro train can be run by either the public or the private sector: the critical thing is that it can and should be an effective competitor to the instinctive purchase of a two- or four-wheelers.

The need for government to be a credible player is especially true in the case of public goods like power, roads, water, education, health and security. We see that in the (1) gen-sets that Indians buy since power availability and quality is uncertain (this means that they are reconciled to making their own power at Rs15 per unit while the utilities shy away from raising prices to say Rs5-7 a unit to make the many idling power plants viable); (2) the two-wheelers and four-wheelers that they buy since they cannot rely on public transport (which means that they will spend Rs2 per km on their scooters and bikes in the city without counting depreciation but city busses will still run at Rs0.25 per km or lower), (3) the flourishing businesses of water purifiers and bottled water (where we will pay anywhere between Rs1 and Rs20 per liter of water but will grudge paying our utilities Rs0.10 per liter); (4) the mushrooming of private schools (where the concept of fees exists as opposed to ‘free’ education in public schools); (5) the wide disparity in services and access to health services between the rich and the poor and (6) the gated communities and private security agencies that have started individually protecting Indians.

What is a cost for one is revenue for another and hence these will indeed be areas of business growth. It is important to train our eyes on the vast entrepreneurial and investment opportunities that this will throw up. In all these cases, the answer is not simply privatization but increasingly the accountability and efficiency of the services being provided by the government. One way to improve accountability and efficiency is to price the services being offered at economic rates: this incentivizes the users (citizens) to demand better outcomes. What is given away free is many-a-times not valued. Bringing in efficiency into the delivery of public goods will require a focus on governing them well and pricing them correctly.

Where price changes worked

Prices, as we have seen, have played a critical role in the development of the story. The interesting aspect is that India has had some positive experiences to report as prices moved around either due to the invisible hand of the market or the iron hand of the government. The large increases in minimum support prices (MSPs) in cereals over the last decade have led to a sharp rise in their output. Fruits and vegetables, the prices of which routinely feature as the cause of high inflation in India, have seen their output almost double in less than a decade; the same story plays out in the dairy sector. The wages of engineering students rose so quickly and so much that millions wanted to becomes engineers – India will now graduate more engineers than China and the USA combined! As the supply increased and demand slowed, Indian engineering collages are now witnessing a sharp drop in enrollments. Similarly, the price of agricultural labor rose so quickly and so fast (in part due to MG-NREGA), that it priced out labor from agriculture and replaced it with tractors (women were especially hard hit).

There is of course hope that the price mechanism will find its roots in India. One of the most ambitious projects in India is to deliver the benefits to the poor via cash transfers. There has been significant focus and debate on the ability of the system to deliver cash and for the participants to benefit from such cash (there is a paternalistic fear that the cash transferred will be blown away, for example, in alcohol). However, the process is carrying forward with more than 700 mn people now enrolling for Aadhar (even as the Supreme Court has made Aadhar non-mandatory for direct benefits transfer).

The more important aspect to focus on is the corollary of giving cash to the poor instead of sending them, for example, grains or fuel. The amount that needs to be paid will need to be determined with reference to a market price. For example, let us say that it is decided that those below poverty line are entitled to say 10 kgs of rice every month at say, Rs1 per kg. Now in order to calculate the sum of money to be transferred into the account of the beneficiary, we will need to know the market price of rice. Assuming that rice costs Rs20 per kg in the market, the government will need to transfer Rs190 into the account of the beneficiary this month. The corollary is hence this: if the beneficiaries are being given cash that means market prices will prevail for the goods so that the value of the transfer can be calculated.

There will be much to celebrate in the transitions. As Indians study more and get battle-ready for newer jobs that will come with economic growth, they will make old shackles irrelevant. These jobs may be in the field of manufacturing or in services but they will surely not be in agriculture (the nature of jobs in agriculture will also undergo dramatic changes – a tractor operator is already replacing manual labor; eventually, harvesting, sorting and warehousing, etc will all get mechanized). Newer jobs will mean moving into cities where they will benefit from the economies of scale in providing them basic public utilities. As Indians get access to these basic utilities, it will help them spend their wallets on not just on the basics of life but on pursuits of leisure: which could mean more days off or higher education on topics of interest.

In many cases there will be iterations in reaching solutions but that the fear of revision (and indeed, retracement) should not hold us back from taking the first step. Two good examples of how the country has been learning come from recent heated debates on the auction of natural resources and the land acquisition act. In both the cases, India has arrived at a solution which is vastly different from what it practiced for many decades. Are the new solutions final and forever binding? No. They will change with time as they develop their new incongruities and inconsistencies. Let us quickly see what we learnt and where we are in the two situations.


Suddenly, after the 3G auctions, the country realized that there is significant value in what was in effect air. Around the same time, the national accountant and auditor pointed out that the process of ‘allocating’ resources like coal have led to immense loss of value for the country. Both these jolts have created the ground for auctioning of natural resources. We have hence moved from ‘allocating’ the resources to ‘auctioning’ them. Is this the end state? No. A couple of decades down the line, we will, as a country, realize that the resources are now getting concentrated in the hands of only those who can participate in the auctions. Invariably, that will mean that the incumbents in the industry, foreign or Indian companies and promoters with deep pockets alone can participate in these auctions. We will then possibly want to figure out a better way of encouraging new entrepreneurs and sharing the wealth around. However, the current crisis demands a current and context-relevant solution and that is what India is currently working to put this in place.

On land acquisitions, the government and its functionaries had become key intermediaries in acquiring land using the state’s power of eminent domain. These land parcels would then be passed on to public or private sector for further development. The land could be one which was rich in natural resources and hence valuable for mining or it could be relevant to industry or real estate players as a convenient place for their construction. This led to the creation of extra-legal elements who helped acquire land and there were many instances of forcible acquisition leading all the way to murder. From such a position where the state could use its unfettered right to take away anyone’s property at price equal to zero, we have now moved to a situation where land acquisition requires individual consent and in case of public projects, consent by a large super-majority. This is now being criticized as being too harsh on those who want to acquire land (and states have started to change the new law and bring in back the old one). Is this hence a closed chapter? No. We will need to design many changes to achieve equilibrium between competing interests. The process of conversion of land from agricultural to non-agricultural remains mired in ways which are openly corrupt. All of this will indeed need to change and the simple thing is to liberate is the price mechanism.