Revel in competition

Business Standard, 18 October 2006

India's airline industry is unhappy about low profits. Early indications suggest that the government will support cartelisation that leads to higher profits. Private firms would of course like to have cosy profits, but there is no reason for the government to cooperate with this. The best policy framework, and the highest goal of economic policy, should be ruthless and ceaseless competition. There is nothing wrong with ups and downs of industry-level profitability. An industry is only competitive if some firms are in dire distress, and there is a regular pace of exit by weak firms paving the way for entry by new firms.

From the viewpoint of consumers, the evolution of the Indian airline industry is a great success story. New kinds of competition has been injected into the market, and the cosy duopoly of Indian Airlines versus Jet has been broken. Incumbents and newcomers are both struggling to figure out business strategies, while the middle class is flying like never before.

CEOs of airlines are, of course, extremely unhappy at the fiercely competitive conditions. It is a big contrast when compared with the cosy situation that prevailed a short while ago, when being an airline was a license to print money. In India, CEOs of airlines have a natural champion: the Minister for Civil Aviation. This is partly because they meet him more often than consumers do, and also because the Minister is effectively the super-CEO of two PSU airlines and will inevitably be contaminated by the perspective of the incumbent.

Press reports suggest that the government might help airlines arrive at an agreement to "voluntarily calibrate capacity addition", "avoid overcapacity", and slow down licenses to new airlines. The chairman of Air India, V. Thulasidas, is said to have convened a meeting in Bombay of all airlines, to discuss how the industry can become a cartel and more effectively earn profits.

As Adam Smith observed:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

The very fact that such a meeting is taking place is a shocking failure of competition policy. There are countries in the world where the CEOs participating in such a meeting would go to prison.

The ethos of the Ministry of Civil Aviation appears to be steeped in socialist India, where the task of government was to oversee an industry and ensure a tidy and happy world for all firms through a planning process. The planner would know how much demand was going to come in the future, and then ration out industrial licenses so as to avoid "wasteful" overcapacity.

We now know this is the wrong path. The removal of industrial licensing led to many problems for firms which invested in building factories but later found they were unable to make profits. This is a perfectly healthy part of the dynamic of capitalism. Profits for incumbent firms must not be the objective of policy. Instead, competitive conditions should be the objective of policy. Lots of manufacturing companies have had difficulties after trade barriers went down and industrial licensing went away - and that is the biggest reason why Indian manufacturing is healthy today.

As Nobel Laureate Edmund Phelps observed last week, A tremendous confusion is created by associating `capitalism' with entrenched wealth and power. Entrenched capitalists would be too happy to entrench themselves, and convert a running firm into a safe sinecure that pumps out profits year after year. But such a world comes about with a socialist license-permit raj, or a Continental Europe framework, where existing firms are shielded from competition through a system of entry barriers. As is seen in many other areas of economics, there is nothing better for the capitalist than the leftist approach to economic policy.

India must aspire to something higher than mere private ownership of the means of production in a cosy, stable, tidy, planned environment that is directed by the bureaucrat and the politician. A mature market economy has ceaseless creative destruction: market share continuously bounces around, yesterday's startup is today's market leader, and yesterday's leader is today's bankruptcy.

When the market economy works, it is untidy, unplanned, unstable and everything but cosy for the firms playing in it. This is the only path to obtaining efficient and innovative firms, where profits are always kept under check, and productivity growth is robust and sustainable. The only healthy market economy is one where firms are constantly born and firms constantly die. Shielding firms from the wild west wind of creative destruction is the path to the malaise of continental Europe.

There are three tangible paths through which greater competition can be injected into the economy:

  1. The first issue is that of reducing government involvement in the economy. If there was no Ministry of Civil Aviation which controlled two big PSU airlines, there would be no mechanism through which government could meddle with competitive conditions. Mature market economies do not have PSU airlines, nor a ministry for civil aviation which can be the convener of a cartel.
  2. The second issue is that of harnessing globalisation. If India followed an unrestricted open skies policy, then cartelisation by airlines in India would invite entry by foreign airlines. Firms like Singapore Airlines and foreign LCCs would undercut Deccan Air on the Bombay-Delhi route. When RBI sets up a cosy life for Indian banks by restricting branch expansion, consumers should be able to shift deposits to Singapore or London. Low trade barriers have done a world of good for competitive conditions in Indian manufacturing. The lessons of this experience need to be applied to more sectors, ranging from airlines to finance to agriculture.
  3. The third piece of the puzzle is the Competition Commission. This involves extremely complex institution building. On one hand, nobody wants a reversion to the days of MRTP, where anti-trust policy was an excuse for strangling Indian firms. But the way forward does involve deregulation, or the removal of traditional government meddling in the economy, and merely focusing on one issue, that of competition policy. One cannot help fantasise about a world where a Competition Commission obtains evidence about this meeting of CEOs of airlines, and manages to send a few of them to prison.

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