Tag: regulation

Inefficiencies in the auto rickshaw market and Uber

Taxi marketplaces such as Uber and Ola address inefficiencies and failures in the auto rickshaw / taxi market

Weary after a long cold night journey you get off the overnight bus from Chennai at Lalbagh’s Double Road gate, and look around for auto rickshaws. There are some ten of them around. The drivers are equally weary, having woken up early and left their homes to stand in the cold, hoping to find passengers alighting from buses. They want to get compensated for this, and quote you a fare that includes such compensation. All of them quote similar fares. You grudgingly bargain and agree, and conclude that Bangalore’s auto drivers are bastards.

Alternate scenario: as the bus reached Madivala, ten minutes away from Lalbagh Double Road gate at that time of the morning, you pull out your app and ask for a taxi to pick you up from Double Road gate in ten minutes’ time. The driver has been up, but resting at home. He leaves home now, just in time to be there at Double Road gate by the time you get off there. Off you get into the car and go.

You have to get to work and try catching an auto rickshaw. The guy asks for extra money for he has to take you through traffic-laden roads, which are a tax on his time, which the regulated fare doesn’t compensate him for. You bargain, get in, and conclude that auto drivers are bastards.

In an alternate scenario, you use an app-based taxi which calculates the fare as a linear combination of distance travelled and time taken, which means that the driver gets compensated for getting stuck in traffic without having to bargain for it. And without you having to think that the driver is a bastard.

In the evening you are trying to get an auto rickshaw from MG Road, and the guy asks for a premium. This premium is not reflective of costs, but the fact that demand for auto rickshaws in that area at that time is high, and that there will be customers willing to pay that premium. You conclude that the auto rickshaw driver is a bastard. Uber’s surge pricing (which can be steep at times) doesn’t evoke the same reaction from you. Uber has centralised knowledge of demand and supply so they can clear prices better, while the auto driver, lacking that knowledge, quotes a price that reflects his lack of market knowledge. And not having a good idea of what to charge, he might try to charge above market price.

What I’m trying to say here is that the local taxi/auto rickshaw market is inefficient, and ridden with failures. There is lack of information flow between demand and supply, which leads to inferior price negotiation, and the transaction cost of time and effort wasted on negotiation as opposed to using that time to travel! And when a market fails, the classic economic response is regulation, but in the case of taxi markets regulation is so poor (regulated prices do not reflect costs) that it enhances the market failure. The (badly) regulated prices anchor into people’s minds unrealistic expectations, and when auto drivers nudge them towards more realistic market prices, passengers assume that they (drivers) are bastards.

It is in this context that players like Uber and Ola (I’m not a fan of Ola’s pricing model, though) step in and try to resolve the market failure by improving flow of demand-supply information and setting “clearing prices” that compensate the driver in line with his costs. If you look closely, these companies are actually rescuing the local taxi market from its inherent inefficiencies and failures and bad regulation!

It is important, however, that no one market place ends up becoming a monopoly. As long as we have two or three different marketplaces, both customers and drivers have the choice of moving between one and the other, and this will ensure that these market places face market pressures from the two sides of the market, and if they “regulate” in an unfair manner, their participants will move to a competing marketplace, resulting in loss of business for the marketplace.

But then, considering the inherent network effects of the marketplace model, I don’t know how we can ensure that competition exists!

 

Other airlines to bail out Spice Jet?

In a rather bizarre move, the Directorate General of Civil Aviation (DGCA) has directed airlines to not charge “exorbitant fares” for passengers stood up upon cancellation of Spice Jet flights. This is a rather bizarre idea and effectively amounts to asking other airlines to partially bail out Spice Jet.

Essentially when an airline is in trouble, passengers are loathe to book tickets on it, for they know that the chances of their flight getting cancelled is high. A cancelled flight usually means either cancelling the trip itself or rebooking on another airline (sometimes airlines have arrangements with each other for taking on passengers on cancelled flights, but currently no other airline in India will give credit to Spice Jet). Either ways, it is a costly affair for the passengers.

By directing airlines to not charge “exorbitant fares”, and assuming that such a directive will be followed (very likely that this directive is meaningless for this is the busy season and other airlines are likely to be booked out), the total cost of booking a ticket on Spice Jet actually comes down, for the charge a customer will have to incur for re booking on another airline for a cancelled Spice Jet flight is likely to be reduced. And thus passengers will not abandon Spice Jet at the rate at which they normally would. And since other airlines are taking a hit on the spot fares they could potentially charge (in the absence of this directive) they are effectively subsidising and “bailing out” Spice Jet!

The other problem is that in the absence of market mechanisms (which the price cap effectively curb), how will other airlines allocate their remaining capacity among all the passengers who have been stood up by Spice Jet? Some arbitrariness is likely to ensue and passengers are likely to be left more disappointed!

The government had started off by handling the Spice Jet case rather well, as Devika Kher has argued here. However, of late, the wheels of the DGCA seem to have come off in his aspect, and there seems to be a concerted attempt to let Spice Jet stay afloat against the wishes of the market. The Airports Authority of India and oil companies have been asked to extend credit for fifteen days.

It seems Devika spoke too soon!

Implementation and rule of law

Draconian laws coupled with lax implementation deliver too much power to regulators. This makes the business environment unpredictable and makes it harder to do business.

Following the arrest for rape of a taxi driver who was hailed using the Uber app, the Delhi government has gone on to ban Uber. Not satisfied with that, it has gone on to ban all other app-based taxi hailing services (Ola and TaxiForSure are the other big ones). Following the incident last weekend, the government has suddenly decided to throw the rule book at these aggregators and accused them of running taxi services without a license. The point to note here is that until the weekend’s alleged rape, it seems that these businesses were all kosher.

A few months back Mint had an excellent piece (I hope I’ve got the link right) on the absurdities of some of India’s labour laws, and pointed out that most companies are in the breach of such laws. Essentially while the labour laws in India are not very short of being Draconian, what allows businesses to do business and people to go about their lives is lax implementation. And it seems that this issue of draconian laws and lax implementation is not restricted to labour alone.

The iconic Bangalore Club in Bangalore has had its liquor license withdrawn following a raid by the excise department last week. The trigger for this raid is alleged to be a case where a security guard of the club refused to let in the car of a police officer who was not carrying his membership card. This is alleged to have led to a series of cases which finally led to the excise raid and the cancellation of the license. It seems that before the police officer’s car was stopped, there was no violation of excise rules.

In a recent dispute on VAT, the Karnataka government has forced Amazon to stop storing third party goods in its “fulfilment centres”. There has since been back and forth on this and the commissioner of commercial taxes who implemented the order has since been transferred. It was initially expected that the Karnataka government would take the legislative route to clarify this tax dispute in the current Assembly session at Belagavi, but that seems to now be put on hold. Instead, it is likely that the laws are going to remain the way they are and Amazon will by “spared” on account of lax implementation.

Lax implementation of laws is a major impediment to doing business, for it removes predicability. Clear laws which are implemented well set down clear rules for businesses and there is little in terms of what is right or wrong. Such laws make it possible for businesses that choose to be “100% legal” to take a path where there is no ambiguity on their activities. Lax implementation, however, biases the playing field in favour of players who are willing to play on the borders of legality and who rely on lax implementation and benevolence by regulators to continue doing business which is technically illegal. Soon, this results in an equilibrium where everyone is in violation of some rule or the other and remains in business only due to the “benevolence” of regulators.

This implies that regulators who are in charge of implementing these draconian laws have enormous powers over the business they regulate, for any move by the business that the regulator does not like can be responded to by a throw of the proverbial rule-book. This places these businesses at the effective control of these regulators and helps perpetrate what Amit Varma calls the “mai-baap sarkar” – where you function solely due to the benevolence of the government or people acting on behalf of it.

Prime Minister Narendra Modi has stated that one of his goals is to improve the ease of doing business in India. As long as we do not have predictable and rule-based implementation of law, it results in giving significantly higher powers to the regulators, which makes the business environment unpredictable, and makes it harder to do business. If we have to improve our ease of doing business ranking to 50 (as stated by Modi), a necessary step is to implement each of our laws in letter and spirit, without any room for ambiguity. Of course this will lead to the diminishing of power of the regulators over their “regulatees”, but solving that is a political problem which the government ought to solve.

Regulation in capital cities

David Henderson notes that taxicab fares in Washington DC are much lower than anywhere else in the US, and for this he mentions the fact that Congressmen are frequent taxicab consumers in DC, and thus oppose any move to restrict supply, as is the case in other American cities.

But, I tell my students, there is one big counterexample: Washington, D.C. Why? Because Congress has a lot of say over the running of the D.C. government. So here the consumers, whose ranks include Congress and Congressional staffers, have a great deal of leverage over the regulators. Result: No way will Congress cooperate in artificially restricting supply and driving up cab fares that they themselves pay. That’s why cab fares in D.C. have traditionally been so low compared to fares for a given distance and time in other U.S. cities.

By that logic, Delhi and other state capital cities should have great public transport and infrastructure since MPs and MLAs are consumers there, and they wouldn’t want to impose higher costs on themselves. Why hasn’t that happened?

The simple answer is that as far as “government servants” in India are concerned, there is private provisioning of such goods. Thus the state takes care of accommodation and transport for these people. Since they live in a concentrated area, such areas are much less likely to suffer power cuts compared to the rest of the city. If you are a more senior government officer (of the grade of minister or chief minister or prime minister, say), you even get right of way on the roads and are not stopped by traffic.

Because we have elected to solve these problems for “government servants” in India by private provisioning rather than public provisioning, such “servants” are not consumers like anyone else. And thus, their presence in a city has no impact on public goods in the same city!

Market forces

This morning I refused to board an auto rickshaw since it had one of those old analogue metres. Most autos in Bangalore nowadays use digital metres, which is the regulation. Except a few like the one I saw in the morning.

Now, given that most autos have digital metres people have a choice to choose only such autos. I’m sure the driver I met this morning will realise soon enough that he’s not getting as much business as he can due to his old metre, and make the switch.

It’s similar with usage of metres. In some parts of Bangalore it’s the norm for auto rickshaws to ply by metre. In such areas any driver who tries to make a quick buck by negotiating a higher fare is likely to lose customers. When a customer knows that after letting go of an auto which asked for excess fare, he had a good chance of finding one that will go by the regulated fare, he is less likely to heed to the demand for excess fare.

You can think of this being a case of what Malcolm gladwell calls the tipping point – once markets have tipped to one side (let’s say using regulated fares for auto rides) there is positive reinforcement that leads to an overwhelming move in that direction.

To get back to the metre example, when the fares increased a few months back traffic cops in Bangalore ran a drive where they checked for auto metres and fined those who had not made the switch by a particular date. Maybe that’s led to about 95% of the metres getting recalibrated. The beauty here is that market forces will take care of pushing this 95% to 100% and cops need not spend any more time and energy on enforcing this! Similarly if cops want to enforce usage of regulated  fares they would waste time by doing this drive in areas where most rides are by metre – the focus should be on tipping the other areas over!

To summarise, some parts of regulation gets enforced by sheer market forces, and regulators should not be wasting their energies there. Focus should instead be given to those areas where market failure is extreme – for that is where regulation has a role to play.

Provisioning for Non Performing Assets at Banks

K C Chakrabarty, a Deputy Governor at the Reserve Bank of India recently made a presentation on the credit quality at Indian banks (HT: Deepak Shenoy). In this presentation Dr. Chakrabarty talks about the deteriorating quality of credit in Indian banks, especially public sector banks.

What caught my eye as I went through the presentation, however, was this graph that he presented on “Gross” and “Net” NPAs (Non-Performing Assets). Now, every bank is required to “provision” for NPAs. If I’ve lent out Rs. 100 and I estimate that I can recover Rs. 98 out of this, I need to “provision” for the other Rs. 2 which I expect to become “bad assets”. Essentially even before there is the default of Rs. 2, you account for it in your books, so that when the default does occur, it won’t be a surprise to either you or your investors.

Now, NPAs are measured in two ways – gross and net. Gross NPAs is just the total assets that you’ve lent out that you cannot recover. Net NPAs are gross NPAs less provisioning – for example, if you expected that this year Rs. 2 out of Rs. 100 will not come back, and indeed you manage to collect Rs. 98, then your Net NPA is zero, since you’ve “provisioned” for the Rs. 2 of assets that went bad. If on the other hand, you’ve expected and provisioned for Rs. 2 out of Rs. 100 to be “bad”, and you manage to collect only Rs. 97, your “Net NPA” is Re. 1, since you now have Gross NPA of Rs. 3 of which only Rs. 2 had been provisioned for.

This graph is from Dr. Chakarabarty’s presentation, indicating the movement of total NPAs (across banks, gross and net) over the years:

Source: Presentation by K C Chakrabarty, RBI Dy. Gov. , via Capital Mind

What should strike you is that the net NPA number has always been strictly positive. What this means is that our banks, collectively, have never provisioned enough to offset the total quantity of loans that went bad. I’m not saying that they are not forecasting accurately enough – loan defaults are mighty hard to forecast and it is hard for the banks to get it right down to the last rupee. What I’m saying is that there seems to be a consistent bias in the forecast – banks are consistently under-forecasting the proportion of their assets that go bad, and are not provisioning enough for it. This has been a consistent trend over the years.

This fundamentally indicates a failure of regulation, on the part of both the bank regulator (RBI) and the stock market regulator (SEBI). That the banks are not provisioning enough means that they are misleading their investors by telling them that they are going to have lesser bad assets than actually are there (SEBI). That the banks are not provisioning enough also means that they are exposing themselves to a higher chance (small, but positive) of defaulting on their deposit holders (RBI).

How would this graph look like if the banks were provisioning properly?

The Gross NPA line would have remained where it is, for it doesn’t depend on provisioning. However, if the banks were provisioning adequately, the Net NPA line should have been hovering around zero, going both positive and negative, but mean-reverting to zero! This is because banks would periodically over and under-forecast their bad assets and provision accordingly, and then dynamically change the model. And so forth..

Read the full post by Deepak to understand more about our bank assets.

Chennai Gets Metered Autos

During my talk at the Takshashila Chennai Shala in 2011 (related Pragati article here), I had argued that the underlying reason for market failure in Chennai autorickshaws was regulatory failure. Despite costs for auto rickshaws going up significantly, I had argued that the regulated fare was a lowly Rs. 7 per kilometer, because of which no auto rickshaw in Chennai traveled by meter.

In the same talk I had argued about the benefits of having a regulated fare (no time wasted in haggling, etc.) so this new move by the Tamil Nadu government to regulate auto rickshaw fares is welcome. Note at the end of the article that someone from the Auto Rickshaw Drivers union has welcomed the new fares. This, and the fact that the fare has been set rather high (compared to other Indian cities) should hopefully lead to wide uptake in the use of meters among auto rickshaws in Chennai.

This stabilization in price, I argue, will lead to greater use of auto rickshaws by the general public (since there is no uncertainty now) and should also contribute to greater revenues for the drivers, thus creating a strong ecosystem.

The graph below compares the per kilometer auto rickshaw fares in different cities in India. Note here that Chennai is the most expensive. My argument, however, is that given the unregulated market that is in place now, this higher fare is a reasonable price to pay for good regulation and fair fares.

 

autos