The Invisible Hands of the Indian Economy

by Gaurav Pallod

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

- Adam Smith, An Inquiry into the Nature & Causes of the Wealth of Nations, Vol 1


Introduction


The freedom to choose your profession is the basis of any capitalist economy. Free markets are revered in all of the developed countries.


Markets are unregulated and resource allocation is left to the markets and the magic of the ‘Invisible Hands’ takes over.


According to the 2019 report on the Index of Economic Freedom, India was categorized as ‘mostly unfree’, with a rank of 129 out of 186 countries. It is within the bottom 30 percentile, with a score of 55.2


We can compare the GDP per capita and Indices of Economic Freedom:



Hence, we can conclude that economic freedom is directly proportional to the growth of an economy. Since India has a low degree of economic freedom, it is safe to say that it is more of a hindrance than a catalyst.


It can be argued that government intervention is useful when markets lead to unfavorable situations, but excessive intervention - especially when markets can increase citizen’s surplus in a more efficient manner - stifles economic freedom.


The government can affect markets either through direct participation (as a market maker or as a buyer or supplier of goods and services), or through indirect participation in private markets (for example, through regulation, taxation, subsidy, or other influence).


When the government acts as a buyer, the demand increases drastically, and then the price is too high. Now due to the high price, the production of goods or services increases way beyond the need (demand).


If the government acts as a seller, then the supply increases, causing the price to go too low. Now, due to the low prices, the consumers want the product more than the producers have available.


In both cases, there is a serious distortion of the market equilibrium and leads to huge deadweight losses - income that is lost forever. Let's take an example and discuss it further.


Essential Commodities Act (ECA), 1955


The Essential Commodities Act (ECA), 1955 was enacted to control the production, and distribution of certain goods such as vegetables, sugar, salt, etc., which are considered to be essential commodities.


When the price of any of these essential commodities rises, the State can restrict the stock holding limits on the commodity, and conduct forced sales.


The said aim of this Act is to ensure the affordability of essential commodities for the poor by restricting hoarding. But this is a huge overreach on the government’s part and can cause huge economic downturns.



We have to understand that agriculture is a seasonal activity, it can not have stable prices without storing left - overproduce in the offseason. ECA intervenes in this mechanism by its frequent and unpredictable imposition of stock limits, thereby disincentivizing storage facilities' investments.


ECA on Controlling Price Volatility


One of the major reasons for the enactment of the ECA was for price stabilization, to attract more firms. But, it has done the exact opposite.


The figure below shows the standard deviation of prices of potato and onion in wholesale and retail, before and after stock limits were imposed under the ECA.



And we can notice that these arbitrary bans on stockpiling can increase volatility, instead of decreasing it.


Other reasons why the ECA is doing more harm than good

Imposing limits on stockpiling reduces the effectiveness of free trade and the flow of commodities from surplus areas to markets with higher demand.


ECA also affects the commodity derivative markets as traders may not be able to deliver on the exchange platform the promised quantity, owing to stock limits.


The Act distorts markets by increasing uncertainty and discouraging the entry of large private sector players into agricultural-marketing.


Here are some more examples of Government regulations which have or should be removed -



Conclusion


Competitive and free markets are the best and most efficient way of allocating resources.


Yes, the utopian conditions required for a perfect market system are rare, but often the costs of State Intervention may outweigh the benefits when market failures are not severe. But, of course, the State must intervene and play a difficult but important role whenever the market failures are extreme.


This article just argues that there are several sectors in the Indian economy where the State needlessly intervenes and even distorts markets.


On the other hand, Government intervention is necessary during an acute market failure. There is no denying that.


But, interventions that were apt in the past, in a different setting, possibly because the market failures were more severe then, may have lost their need in the modern economy where those particular market failures are not severe.


Eliminating such instances of needless Government intervention will definitely improve markets and thereby spur investments and economic growth.


“A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.”

- Milton Friedman




References

https://www.indiabudget.gov.in/economicsurvey/doc/vol1chapter/echap04_vol1.pdf


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