Ill-informed debate on oil decontrol

The government has finally hiked the prices of diesel, kerosene and LPG, though by less than recommended by the Kirit Parikh Committee. It has decontrolled petrol , and hopes to decontrol diesel in due course. But its timidity suggests that price controls will return if global oil prices shoot up again.

Financial TV channels had discussions clearly favouring decontrol. But politicians on news channels were overwhelmingly against any price rise. Their objections included exaggerations, halftruths and plain falsehoods.

They said this was a political issue affecting the common man, and could not be treated just as an economic matter. Yet, dozens of countries across the globe have no price controls.

The common man in Japan, the Philippines or the US treats changes in petrol and diesel prices as no more political than changes in the price of bananas or eggs. Only when governments impose price control do prices become political, and that’s the best reason for avoiding controls. India had no oil price controls till 1973, and price changes were not seen as political then.

Indian politicians claim that the common man will be pushed into poverty and privation by the price hike, while farmers and agriculture will be ruined. That’s plain wrong, and such claims have no basis either in other country experiences nor India’s own past. The common man faces price changes up and down in any market system.

In a non-market communist system, all prices can indeed be controlled forever, but the collapse of the Soviet Union showed how myopic and bankrupt such an approach really was. Price controls can provide shortterm relief to consumers, but act as longer-term disincentives to production and efficiency, the cumulative impact of which toppled communism.

Deng Xiaoping in China moved towards the market fast enough to escape a Soviet-type collapse. Countries without price controls have far outperformed those with controls, in terms of poverty removal no less than GDP growth. Yet, Indian politicians on TV talk as though Soviet-style price controls are the only rational and humane way to manage economies.

Indian politicians claim that price decontrols will spur inflation. But despite price controls, India has 10% wholesale price inflation and 14% consumer price inflation.

By contrast, inflation is just 2-3 % in the US, Europe, Japan, the Philippines and other countries without price controls, where consumers are paying in full for the doubling of crude price from $40 to $80 a barrel over the last year. Inflation is caused by faulty fiscal , monetary and trade policies, not by price decontrol.

Diesel and petrol have gone up around 5%, which is hardly sensational. Yet Indian politicians say the back of the common man will be broken.

Really? Between 1970 and 1973, crude went up from $1.20 a barrel to $3.65 a barrel, and this tripling was passed on in full to the Indian consumer. Then Opec became an effective oil cartel in 1973-74 , and oil shot up to $10 a barrel . Once again, the Indira Gandhi government passed on the rise to the consumer . Obviously it hurt. But the economy adjusted, and agriculturists did not commit suicide.

Next came the second oil shock of 1980. Crude tripled from $10 a barrel to $30 a barrel. Again, Indira Gandhi passed on almost all the burden to the consumer. Once again, the consumer adjusted , with no economic collapse or impoverishment.

Indeed, poverty started falling for the first time after Independence . Leftists claimed that farmers would be decimated. In fact, the green revolution spread fast after the first oil shock of 1973-74 , and again after the second oil shock of 1980. Higher petrol and diesel prices went hand in hand with falling poverty and rising farm production.

Communists are the biggest critics of higher prices, claiming that these are an artificial creation of speculation by ‘international financial capital’.

This is eerily Hitlerian. Hitler too claimed that the global economy was controlled and distorted by financiers, who were mainly Jews, and so resorted to mass murder of Jews. Communists perpetrated mass murder of another sort, based on class rather religion, but with as little moral or factual basis.

To be fair, communists are not alone in blaming financial speculation for artificially driving up oil prices. The trading volume of oil futures and derivatives has skyrocketed in the last decade, when prices too skyrocketed before nosediving. Academic studies have investigated the possibility that financial speculation made oil prices especially high and volatile.

But these studies failed to establish a link. Other commodities like iron ore, coal, uranium and cobalt are traded for physical delivery only in the spot market , and have no derivative markets.

Yet, the prices of iron ore and coal proved if anything more volatile than that of oil. Iron ore shot up from $40 to over $200 a tonne in the boom.

Why so? Well, 2004-08 witnessed the mother of all booms, with world GDP growing at a record rate. Environmental and safety clearances made the opening of new mines a lengthy process. Hence, commodity supplies could not keep up with demand, and enormous price spikes were the result. The oil price spike was not exceptional. For every financial seller there was necessarily a buyer too, so speculation did not create one-way trends.

Why has trading in oil futures and derivatives skyrocketed? Some of it is pure speculation. But much trading is now related to risk management, both by suppliers and consumers, who hedge against adverse developments by locking in future prices. This constitutes a rational form of insurance. Communists who condemn this blindly as ‘international financial capital speculation’ are simply exposing their ignorance.

These comrades need bogeymen to justify their life-long defence of communist murder and torture in pursuit of a bankrupt economic ideology. Rather than learn from the collapse of the Soviet Union, they would rather use old, hollow slogans to justify the unjustifiable. When exposed by newspapers like this one, they have no factual reply, but repeat empty slogans about the pink press being the voice of international financial capital. How pathetic!

7 thoughts on “Ill-informed debate on oil decontrol

  • 2010.Jul.12 at 22:04
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    Dear Mr. Aiyyar,

    I am thankful that a man with liberal and progressive economic views such as you has found a place on the National Economic Advisory Council. I hope you will be able to infuse some sensible policy into brazenly populist and spend-thrift measures that have highlited the tenures of every Indian government since Indira Gandhi’s.

    Many people in our country think that the benevolent, motherly hand of government will save our country. In fact, everything to do with government in India is a mess. We need individuals to be given empowerment, and that can only happen when the “benevolent zoo-keepers” get out of their way.

    I agree that strong regulations, progressive taxation, consumption taxes and a strong national defence are necessary for stability, but in almost all other respects, the government must get out. Farmers should be allowed to farm to the market, and the benevolent labour laws that do more harm than good must be drastically scaled back. Only then will our country grow.

    And additional point: Cutting down on subsidies will help us geo-politically as the market mechanism will make options like nuclear energy, solar and wind power more favourable. These will benefit the environment and our strategic interests.

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  • 2010.Jul.09 at 15:30
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    Very well said.

    The Govt. has made a very good move by removing price controls and letting the market decide the price of Oil. Had we continued such populist measures, out Govt would eventually had faced a similar debt crisis which is engulfing Greece.

    Although the short term implications of such a move are not in favour of the Govt (strikes/protests), in the long run it is bound to improve the state of the economy and the country.

    I hope they let the currency also float freely without manipulation some day.

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  • 2010.Jul.06 at 07:27
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    “This is eerily Hitlerian. Hitler too claimed that the global economy was controlled and distorted by financiers, who were mainly Jews, and so resorted to mass murder of Jews. Communists perpetrated mass murder of another sort, based on class rather religion, but with as little moral or factual basis.”

    Reductio ad Hitlerum. It would seem that the debate around “oil decontrol” (perhaps you mean deregulation?) isn’t the only thing that’s ill-informed.

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  • 2010.Jul.05 at 19:49
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    Dear Mr Aiyer,
    Price control is the minimum job expected from the Government,free market economy may be good for affluent section of the society which is miniscule.The farmers and labourers which constitute 90% of the Indian population need the control button in Government hands. I wish to elaborate the point raised by sudhir panwar further,the farm produce are always in excess at the harvest time or when these are under the possession of farmers and labourers are always in excess,the rate of excessive goods and services in market is known to all without special knowledge of Economics.We need honest,sensible and timely market intervention from the Government,but it is a matter of frustration that Government has invented the rolle of ‘facilitator and enabler’for the market forces and dole provider to common men.Yes suicide is not the the early indicator of economic stress,0% economic growth,lack of public investment,skewed term of trade and overall frustration reflected in different uprisings in various parts are the indicators of future.As Communism was not right for economic prosperity so capitalism is also not good for economic situation of the country.

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  • 2010.Jul.03 at 14:19
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    Sir,

    Thanks for this post. I was looking for content that would help me understand the effect of de-control.

    Your article is useful the extent that it analysizes the past behavior and rationalizing that it is only prudent to let prices be decided by market forces.

    Also, you have bashed communists, I am no great fan of communism either. Saying that it will not affect common man based on the earlier effects of absorptions, may not present a complete picture.

    Can you consider an article on what will happen/effects of the move to decontrol? How do equations change or what changes will be required to ensure that what communists fear doesn’t come true?

    Regards,
    Ganesh

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  • 2010.Jul.03 at 01:07
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    .Interesting correlations between petro price hike and economic growth, hope it will work again. The impact of price hike is unique in agriculture sector; almost all the sectors transfer the burden of price hike on consumers either directly as in transport sector which is evident in 12% hike in freight rates, 30% in auto fare or indirectly through intermediaries as in industry sector. But in agriculture sector the hike is not translated into the higher price of farm produce, as market decide the price of most of the commodities on demand and supply basis, irrespective of input prices .The CACP decide price of some commodities but their main concern is consumers and not the input costs incurred by farmers. Is it economically sound to expose the farmers to the volatility of diesel price? There is difference in 1970-1980 and 2010 farming as today it is dependent heavily on diesel machines for irrigation and other farm operations. Yes there are several countries where oil price is decided by the markets as cited in the article but agriculture is heavily subsidized in these countries. The open ended subsidy may not be continuing forever but it is also the duty of the democratic Government to rationalize the burden of price rise through targeted approach. It is not the question of communist or capitalist but the affordability and suicide is not the only indicator of economic stress.

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  • 2010.Jul.01 at 15:38
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    Dear Mr.Aiyar,

    I am a good fan of your articles & reading since so long, but your current article “Ill-informed debate on oil decontrol” disappointed me, I was feeling like I am reading an article of some foreign writer from US or Europe. I think definition of liberal economist have changed to some one who think like an European or American and makes opinion by ignoring the difference of social status of India & western world.

    Your opinion about decontrolling the price ignores the fact that people are already paying more than double of base price of petrol & diesel .instead of passing on some portion of this taxation to under recoveries both state & central government want to pass on this to common Indians.

    Instead of increasing tax collection from some easy sources like by scraping “double taxation avoidance treaty with Mauritius or through windfall taxes on extraction of Natural substances and by increasing the base of taxpayers government still want to exploit common people.
    I believe your writing must reflect the mass consensus as well, its not only about decontrolling of prices but any other policy reform which affect majority of Indian and notonly corporate and government.

    Shailesh

    Reply

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