No work for tinkers

Right question: is cartel pricing feeding inflation? Wrong answer: Micro manage prices

There is Portland cement bagged within a factory, Portland cement bagged outside the factory, cement clinker and cement produced by mini plants. What should their excise duty be? If you are a reformist government, you will believe in two propositions. First, there is no justification for specific duties. Since these are always arbitrary, it is best to replace them with ad valorem tax on value instead of on price, a rationale accepted for white cement, but not for any other variety. White cement has less iron. Portland cement has more iron and is therefore grey, rendering it relatively useless for situations where artificial pigmentation is required. This doesn8217;t explain why white cement should have excise of 16 per cent and why there should be specific duties for others. Second, a reformist government will not believe in differentiation across different types of cement, since this is arbitrary. Cement is the base of many infrastructure initiatives. If tax reform for cement is indicative of the base of reform, this budget should have converted all specific duties to ad valorem and adopted 16 per cent as the now standardised VAT rate.

All of us remember the expression, 8216;If wishes were horses, beggars would ride8217;. We may not always remember that the last line of this Mother Goose rhyme is, 8216;There8217;d be no work for tinkers.8217; So much for reformist wishes. In this budget, we not only have specific duties and differentiation, but there is differentiation according to maximum retail price MRP. If cement price per bag 50 kg is less than Rs 190, excise duty has been slashed from Rs 400 to Rs 350 per tonne. If MRP is more than Rs 190, excise has been increased to Rs 600 per tonne. That8217;s only for maxi or midi plants. For a mini plant, excise is Rs 370 if MRP is more than Rs 190 and Rs 220 if MRP is less than Rs 190.

Why has this been done? Somewhere in our mindsets, there is probably the belief that cement is core and should be treated differently. Market forces cannot be allowed to function. Consequently, other than import duty reductions in 2005-06 and 2006-07, budget 2005-06 also tinkered with excise on clinker. That apart, there is the spectre of inflation. Cement contributes 1.73 per cent weight to the wholesale price index.

However, there is a difference between appearing to do something and action leading to results. Witness the pre-budget anti-inflationary exercise of reducing import duty on cement from 12.5 per cent to 0 per cent. That hasn8217;t had any impact. International market prices are higher than domestic prices. It is difficult to import cement in bulk. Nor can Indian ports handle large cement imports. Excise duty changes will also probably not reduce prices, since expectations of MRP reduction or higher excise absorbed by cement companies won8217;t materialise. Most undergraduate economics texts have applied cases on what happens to prices consequent to indirect tax changes. One doesn8217;t need to study economics to figure out the answer depends on supply and demand elasticities. India8217;s per capita cement consumption is only 125 kg. China has 800 kg. If the Indian growth story continues, and there is no reason why it shouldn8217;t, demand will be strong. There are some regional supply-demand mismatches. But ignoring this, prices will simply increase and several cement companies have already announced new prices on March 1. Where does that leave the anti-inflationary initiative?

The best antidote to high prices is supply-side adjustments. Supply-demand mismatches lead to high prices and profitability. That stimulates investments and capacity additions, which eventually drive down prices and profitability. India8217;s installed cement capacity is between 152 and 165 million tonnes, depending on whether you count or exclude mini plants. There are more than 400 plants, but industry is fragmented and the top five producers probably account for 50 per cent of capacity. The point is that India is already the second largest cement market in the world, after China. It isn8217;t very surprising that major global cement companies are entering India through mergers and acquisitions and consolidation is taking place. The foreign hand probably controls 25 per cent of the market now. However, capacity utilisation is high and expansion plans that result in new capacity creation won8217;t materialise till 2008. Hence, there is a time-lag angle to the undergraduate proposition. That apart, there is the stench of cartels, inevitable when there are a small number of players, large concentration true, barriers to entry true, ability of large players to exchange price and other information true and an effective trade association that can take action against those who renege on a cartel contract true.

It isn8217;t surprising that cement figures in the list of manufacturing sectors where cartel formation has been alleged; steel, tyres, Copper T, soda ash, bulk vitamins are others. It is no one8217;s suggestion that perfect competition always exists. Several assumptions behind the neoclassical theory of perfectly competitive behaviour aren8217;t satisfied, which is why most countries have competition policy instruments to particularly guard against unfair vis-a-vis the consumer and restrictive vis-a-vis other producers trade practices. Such anti-competitive conduct can create artificial barriers to entry. Most countries have competition policies that don8217;t focus that much on structure competition will break down market shares or performance prices and profitability, since those too will be whittled down by competition. However, most countries rightly have independent regulators to handle these issues.

The spectre haunting India is not inflation, but price control through executive fiat. In a succession of instances across diverse sectors, particularly since UPA government8217;s advent, we have witnessed attempts to influence prices. Other than its dysfunctional emphasis on prices, as opposed to conducting policies, these attempts deny the regulator its role and fail to recognise that fostering competition requires technical expertise and some appreciation of economic principles.

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We had a Competition Commission Act in 2000, and Competition Commission of India was established in 2003. There can be post facto justifications of why CCI is still not functional. But the core problem is that the government simply doesn8217;t want to let go.

Here is the complete rhyme. 8216;If wishes were horses, beggars would ride. If turnips were watches, I would wear one by my side. And if 8216;ifs8217; and 8216;ands8217; were pots and pans, there8217;d be no work for tinkers!8217;

The writer is an economist