Jag Venugopal's Blog

August 5, 2011

How Government Policies Twist Market Functioning

Filed under: India — Jag @ 6:28 am

Diesel cars are not very popular in the United States. They’re nosier, cost more to purchase and maintain, and belch out black, sooty smoke.

Which leads one to wonder — why is diesel such a popular fuel in India? If anything petrol (gasoline) engines should be more popular because they are cheaper, easier to maintain, and their exhaust isn’t so miserable.

The answer to this question is found in diesel subsidies. Diesel is cheaper than petrol by a third at the pump. Petrol buyers are overcharged, and some of the extra money levied is used to make other fuels such as diesel, kerosene and cooking gas cheaper. The excuse for subsidizing diesel is that it is used by truckers, and keeping the price of diesel under control helps keep overall prices in check. Kerosene is cooking fuel for poor people, and cooking gas is the same for the middle class.

Faced with such market-distorting subsidies, Indians have done what they do best — adapt. India is likely the world leader in the production of small diesel engines for three wheelers, small cars, and assorted other applications. And it is likely to retain that crown, not necessarily due to any technical prowess, but because there is no market for tiny diesel engines elsewhere. Similarly, artificially cheaper kerosene is often used as a fuel adulterant. And, drivers who value economy over safety have jerry-rigged their cars to run on cooking gas rather than petrol.

The latest news is that the government is considering making car owners pay more for diesel, as compared to truckers. I can foresee the famous Indian concept of adaptability (or “jugaad” in local lingo) at work: trucker goes, fills up, then pulls up to side of road, siphons off diesel to sell to motorists for a small premium. Petrol pump (gas station) owners could themselves get in on the act, marking in their books that a certain quantity of diesel was sold to a trucker, while in practice they would have sold it to a car owner for an under-the-table premium.

At the end of the day, government distortions of market-based pricing will not work. No government, howsoever powerful, can ultimately beat Adam Smith’s invisible hand.

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