Fettering the Markets

Vince Cable recently said that corporate behaviour was murky, bankers were greedy, capitalism was a competition-killer. Well, Mr. Cable gets certainly no points for eloquence, yet there was nothing particularly offensive about the substance of his remarks. We have known for a long time that unfettered markets do not deliver the social good. So, why is there such a huge backlash from the city and the media.

Through the history, unfettered markets have delivered the society to disastrous consequences. Slavery being the best known example. We associate prosperity with a government that has a strong fiscal capacity (ability to tax and spend) and an ability to deliver market supporting public goods, i.e., regulate the markets effectively so that they deliver the social goods. (Besley and Ghatak, 2001, 2003)

There seemed to have been a surprising back lash at what Mr. Cable said. What surprised me was how organised and orchestrated it seemed. Mr. Cable’s tone was certainly irreverent and emotional. After all, why bring the words murky, greed and capitalism into it. But to understand the precise reason for the backlash, we have to think of the role regulation plays in maintaining market competition in the services industry.

Regulating the services sector (banking, law industry etc.) is not easy. The services sector produces an output that has significant information problems associated with it, i.e., the consumers are not able to assess the quality of the good before buying it. The information problems are circumvented by the service producers developing reputations for producing reliable services. Cost of acquiring reputation is often steep in these industries. This makes entry into these markets become extremely costly and the industry naturally gravitates towards a monopolistic competition environment.

In a monopolistic competition environment, the firms pays an upfront fixed cost to the enter the market before it can start producing in the market. The fixed cost could be the cost of setting up the factory, the cost of acquiring the correct permits, cost of researching and developing a particular product or the cost of acquiring a reputation for reliability. The size or the volume of the markets and the fixed cost of entering the market together give you the number of firms that the market would be able to support.

In the services sector, given the problem of reliability, the up front fixed cost is often the cost of acquiring the reputation. An entrant that does not have sufficiently deep pockets would not able to enter such a market. See Banerjee and Duflo for an excellent study on the software sector in India and specific cost of developing reputation in this sector. (A. Banerjee and E. Duflo, 2000)

Does monopolistic competition deliver the social good for the society? The answer is a definite yes. There are a lot of sectors that have monopolistic competition and deliver the social good.

But, there is another level of complication here. What is the relationship between regulation and cost of acquiring the reputation. Regulation reduces the cost of acquiring reputation. If the firm meets the regulatory requirements, the consumer does not have to worry about the reliability of the firm.

If the regulation is sufficiently stringent, the significance of regulation decreases driving down the cost of entry. As the fixed cost of entry decreases, there are more players in the market and price of output decreases as a direct result of a lower initial fixed cost that needs to be recovered by the firms. With monopolistic competition per se, the firms are not really able to charge any kinds of rents. The price of the output is sufficiently higher than the variable cost so that it allow the firm to recover the initial fixed cost.

When does monopolistic competition become bad for the society? Essentially, this happens when the firms in the economy are able to collude with each other and influence the regulation that effects that sector. Think of the political economy of regulation. If the market incumbents are able to influence the regulation, what kind of regulation would they like. They would like to drive up the potential cost of entry into the market. This would ensure that only the collusive incumbents remain in the market. If the set of incumbents are stable, their ability to collectively influence the policy becomes greater over time, leading to a vicious circle.

The are many ways to drive up the fixed cost of entry. You could burden the firms that are entering the market with all kinds of regulation that put the new entrants to a disadvantage compared to the incumbents. The most extreme case of this was the “license raj” in India till the mid 80s. The firms had to obtain a license to produce. The regulators (bureaucrats and politicians) would compare the payoffs from the new entrants and incumbents before deciding on the license. Over time as the incumbents grew strong, the new entrants found it difficult to outbid the incumbents and the entry virtually stopped in the market. The oft quoted example of this is the car industry in India, where for decades there were only two players in the market. The market over time grew so lucrative that the government itself entered into the market as the third player in the early 80s.

Of course, if the quality of particular output is not obvious from the start, only firms with reputation for reliability would be able to operate in that market. In that case, lowering the regulation may prove of beneficial as it increase the need for reputation and increases the fixed cost of entry into the market. Thus, counter-intuitively, in these markets, the incumbents could argue for lower regulation.

Ironically, by singing praises of free markets, the services sector has limited the number of players in the market and ensured lack of effective ex post competition. This has been a two-pronged strategy. The first strategy has been to influence the regulators directly and convince them that there is no need for regulation. The second strategy is to build a narrative for the society through an extensive media campaign. In both cases, these market fundamentalist are using the using the free market slogan to effectively reduce the competition in the market.

Vince Cable’s observations were not off the mark. He of course underestimated the ability of the service sector incumbents to use the media to discredit anything that deviates from the narrative. It is indeed puzzling that four decades on after Akerlof’s lemon’s paper, we as society still think that free markets work and anybody who interferes with it is evil. (Akerlof, 1970)

As a society, collectively empowering our regulators to deliver the social good is extremely important. We often talk of regulators that are influenced. The bigger problems is that the society can collectively be influenced by vested interests to think that unfettered markets are always good for us. It is thus extremely important for the social scientists to challenge the free market slogan and explain the precise caveats the markets come with.

References:
A. Banerjee and E. Duflo (2000). Reputation effects and the limits of contracting: A study of the indian software industry. Quarterly Journal of Economics, 115(3):989–1017.

T. Besley and M. Ghatak (2003). Public goods and economic development. Prepared for Policies for Poverty Alleviation (ed.) Abhijit Banerjee, Roland Benabou, and Dilip Mookherjee.

T. Besley and M. Ghatak (2001). Government versus private ownership of public goods*. Quarterly Journal of Economics, 116(4):1343–1372.

G. Akerlof (1970). The market for” lemons”: Quality uncertainty and the market mechanism. The quarterly journal of economics, pages 488–500.

The Southern Barbarians

The Southern Barbarians are actually quite hospitable, once you can find them. Walking through the beautifully lit streets of the French Concession, the address for the Southern Barbarians led me to one of the innumerable plazas that dot Shanghai.

It was late by Shanghai standards. The hustle bustle on the streets was slowly dying away. The address took me to the a deserted but glittering Shanghai plaza or shopping arcade. There was no sign of the barbarians. I walked the length and the breath of the plaza but there was a very little sign of life. Right at the back of the plaza, in an alley that was much seedier than the rest of the plaza, there were three rows of chefs standing in attention and being lectured by what looked like their stern and serious leader. Their faces had a sincere expression with a hint of alarm. It looked like they were being given a dressing down, which required privacy and so I turned back. Walking around Shanghai, it is not uncommon to see employees standing in attention listening to their respective leaders. I have no idea what wisdom was being imparted but the whole scenario certainly looked like it was in a martial tradition.

I finally found the caretaker and showed him the address I had. He pointed me back in the direction of the lined up chef and so I had no choice to head back to the courtyard. As I was plucking up courage to interrupt the leader and ask him about the address, an angelic girl emerged from the dark shadows. She was unmistakably as tourist. It took a lot of effort to reach the Southern Barbarians. But it was all worth it.

Southern Barbarians specialise in the cuisine from Yunnan. Yunnan is one of the southern most provinces of China and borders Burma, Vietnam and Laos. The vegetarian component in the menu was remarkable. I orders spicy yunanese roots against the advice of the waiter. The roots very crunchy with a slight hint of woodiness. They were certainly spicy and very refreshing to eat. Next came pomegranate flowers with garlic chives. I had never imagined that pomegranate flowers could be so tasty. The flowers very green and crunchy. They had been very lightly sautéed. The result was pure bliss. The meal was finished off with a generous portion of a wild mushroom hotpot. The mushrooms were plump and varied and the hotpot hot and comforting. It was a bit on the bland side allowing me to fully appreciate the variety of wild mushrooms in the hotpot.

Details:
Southern Barbarians
2F Area E
56 Life Art Space 169 Jinxian Lu
near Maoming Nanlu
Shanghai
Tel.: 1362 1797 634

Pointillism Revisited

A friend introduced me to the work of Damian Ortega. Ortega’s installations are fascinating. In his 2002 installation Cosmic Thing, he took apart a Volkswagen and re-assembled it piece by piece by suspending it in mid-air. Similarly in other installations, Ortega plays with the idea of transition. You do not know whether the object is being created or destroyed.
Ortega likes to deconstruct objects and then reconstruct them to explore the relationship between the internal and the external space. There is stillness, yet an overwhelming sense of movement and suspense in his installations. As if he has been able to freeze the object in time just before something significant is about to happen.
Cosmic Thing reminded me a lot of pointillism. In it Ortega plays with the light, reinterpreting the object by letting light slip through between the internal space of the object. Just the way artists Seurat and Signac played with light and created images from dots by the process of partitive mixing of colours. Yet, Ortega takes his installations beyond craft and flirts with the viewer without giving away much. He started as a political cartoonist in Mexico and his retains his work retains a sense of playfulness.

 

Lake Palace Hotel

There are romantic places in the world. And then there is Lake Palace Hotel in Udaipur. Emerging from the Pichola Lake like a ghostly apparition, the brilliantly white summer palace for the rulers of the Mewar dynasty is sumptuous in its offering. To add to the mystique, the hotel is only accessible by boats. It is built on a natural island, which is now entirely covered by the palace. From afar, it looks like the the palace is just floating in the Lake.

We went there on a really dark moonless wet night. There rain was like a fine mist in the air and the lake was brimming with water. As we approached the Palace on the boat, palace seemed to emerge from the dark waters of Lake Pichola. Flowing curtains in the window, subdued light in the courtyard and a restrained sense of opulence. Rivulets snaking along the walls of the palace refreshing in the usually oppressive desert heat of Rajasthan.

The palace was restored and converted into a luxury hotel in 1971. The Taj group runs a really exclusive hotel in the palace now. The hotel is as luxurious on the inside as beautiful it is on the outside. There are two restaurants, one for Indian cuisine and the other for multi-cuisine. The food is not exceptional but the ambience is fantastic. We ate at Jharokha, the multi-cuisine restaurants with a fantastic view of the lake. The service was polite and the food well presented.

In terms of ambience, it is very difficult to beat the Lake Palace Hotel. As one would expect, it is expensive. But, I think it is worth an occasional splurge.

A thoughtful movie

Everyone in India is watching talking about Peepli Live. After a long time a movie has caught the imagination of the country as a whole. (Link to the movie’s funky website.)

The plot starts innocuously with a poor indebted farmer called Natha contemplating suicide as a way of repaying his family’s debt. There are rumours of generous compensations for the family of the farmers that commit suicide due of indebtedness. Natha, sees this as a way of providing for his family after his death. He starts speculating about it in public and the story finds its way into the local vernacular press. Turns out that there is political battle brewing over the upcoming bye-election in that area. Overnight the national media, the politicians and the bureaucrats and the rest of the country get hooked into the story. Everyone starts trying to use the story to advance their owns interests as the story starts to snowball.

What ensures can only be described an gladiatorial contest. As the country becomes conscious about the imminent suicide of Natha through the media, various institutional components of the country get inter-locked in a battle to extract the most of out of the story for their own gain.

The beauty of the movie lies in its ability of capture the nuanced interaction between the various institutional components of the society. The bureaucracy, the media, the political establishment and a country hungry to consume sensational news.

Art is often an artist’s perception of reality. It often is not able to escape a particular perspective. Too often in the post-modern world, the perspective is celebrated and glorified. This is a reflection of the move towards self-reliance that accompanies modernisation.

Maybe, that is why it is difficult to come across art that is able to faithfully represent and explores the complexity of the world around us. The world around is woven from strands of reality that individuals experience. The sum of the whole is very different from each components. It is rare that an piece of art goes beyond a few strands. The complexity of the world is rarely captured in any form of art. If at all it is captured, it in the sterile general equilibrium models in Economics. It is welcome change of watch a movie that captures reality in a entertaining way and restrains itself from simplifying the world into black and white.

Elite capture of government machinery is a fairly clichéd theme. Peepli Live goes beyond that the obvious themes and is very deftly able to explore the tension within various institutions along the rural urban line. The suave urban TV anchor patronises the local news paper reporter. The local politician outmanoeuvres other more powerful national politician. The village politics drives national politics. The movie is extremely restrained in it portrayal and leaves the viewer to observe what is happening and to make up their minds.

The viewer observes the superstructure of the society grinding against the changing ground realities. This symbolises the permanent revolution that has gripped the nation since the early 1980s. The incumbents hang on to power, very hesitant to let go as the power centre’s dissolve and get more diversified. Recent work is telling us that the change in the country is not a result of the some brilliant insightful master plan by the incumbent policy makers and power brokers. It is a result of people forcing the policy makers and power brokers to let go. See Basu & Maertens (2007) for a very accessible account of this.

The power that centralised till the 1980 has slowly seeped away, resulting in a resurgent rural India. (See Deaton and Dreze, 2002) The rural India is slowly trying to hold the urban India accountable, while the urban India is hungry for resources and ready to grab anything and everything. The parallel with Singur, Yamuna Expressway or the Maoist insurgency in the tribal heartlands is inescapable.

In a strange way, I see Peepli Live as a complement to the Guru, a Mani Ratnam film made in 2007. Guru portrayed the resurgent India from a different perspective.  Guru is a story of Dhirubhai Ambani taking on the coterie of the industrialist and politicians that had shackled India for their own gains through license raj till 1980s. He is able to break their stranglehold by deviating from the prescribed law and accumulating enough wealth to take on the interest groups.

The power no longer lies within a small coterie. Various changes in the country has ensured that the power is geographically and socially diversified. There are many smaller power centre. Any policy or change is a result of the bargaining process between the various power centres. Institutional change as a result is on one hand painful slow but on the other hand more responsive to needs to of the people. The movie’s sophistication lies in its ability to capture this contradiction. Everyone in the country cares about Natha, yet nothing really changes.

A lot has been written about the ongoing transformation in India. The process of transformation is messy and elongated. There are winners and losers locking their horns like gladiators. India is shinning only for a minority. Peepli Live is just a ringside spectator, merely observing the gladiatorial contest. It dispassionately portrays what is observes without either getting swayed by emotions or wincing at the pain inflicted by the participants of the contest on each other. It is frightening how much life in India is like a gladiatorial conquest, where only the strongest walk out of the ring alive. The hope is that this is the just the birthing pains of new more equitable society of the future.

References:

K Basu and A Maertens (2007). The pattern and causes of economic growth in India. Oxford Review of Economic Policy.

A Deaton and J Dreze (2002). Poverty and inequality in India: a re-examination. Economic and Political Weekly.