Why price controls are bad

Last week, I caught up with the head of a large steel company. "We are losing a few hundred crores every month because of the government's anti-inflationary move to hold steel prices," he told me.

I asked him how demand was doing, particularly from sectors like auto. "We've cut our production of cold rolled steel by almost half," he said, adding that global steel prices were ruling at a premium of roughly 30 per cent to domestic. And there was no way to pass on their own input price increases.

But were not auto numbers still looking strong, I asked. "There is a lag, you have to see it from next month," he said. Then the conversation turned to the election math. After running through several likely scenarios, he predicted that the final battle would be very very close.

If I were to recount similar conversations with other industry leaders in the last few weeks, I would conclude the following. Most are now convinced that the "bear" is at the door, so to speak. To some extent they are also prepared to tackle the bear. But, they feel let down by both politics and economics.

Unlike in the past, I am getting the sense that business leaders today don't want to be protected or given a sense of stability when clearly it's anything but that elsewhere. Particularly they can see and experience what's happening around the world. "Why can't we increase oil prices and give out the right price signals," asked the steel man.

That question got me thinking. Have our businessmen acquired a conscience of sorts? Particularly since for decades they mined the fact that India was a protected market. It's possible they would not mind a return to protection. The problem is that they've invested too much in the other direction now to give up that way of life. Also in a funny way, many of them have less to benefit from the Indian consumer compared to before.

This is because most successful Indian companies have become considerably global in presence and thus, also in outlook. It's tough, as I gathered, for most Indian companies to now think of a single market that they have an advantage in or not, such as India. Here is an illustration. Firms like Vedanta Resources, Jindal Steel and Tata Steel are today in a race for natural mineral resources all over the globe.

To step back for a moment, all these years, I was given to understand that natural resources like iron ore are mined in developing countries like India and sent to the developed countries like the US and Japan where the processing, manufacturing and value addition would take place. Quite the contrary it appears. Vedanta and Jindal are bidding actively for mines in the heart of North America and will, in some if not all probability, bring the ore back to India to convert into steel or copper as the case might be!

I would love to understand the numbers here a little better but I am told by the folks putting together these bids that they actually make sense.

There are several more equations of such nature that are evolving or have evolved with greater integration with the global marketplace. Today, Indian-owned companies could manufacture partly in India and export elsewhere for value addition or sometimes do no manufacturing locally at all.

Tata Steel and Corus or Tata Motors and Jaguar-Land Rover are cases in point where the acquired assets have limited or no role to play in the domestic market. Or Mahindra & Mahindra, where tractors made by its joint venture company in China might only head for the US.

Here is another illustration of how complex the equations have become. A company like Vedanta manufactures alumunium and copper locally, for which it may import ore from its private mines overseas, in Zambia and Australia. Yes, the alumunium plant may well be once government-owned. On the other hand, Vedanta owns iron ore mines via its acquisition of Sesa Goa. And this iron ore is mostly headed down the Mandovi river into the Arabian Sea for China and other iron ore hungry markets. At least at this point.

The only resource that is clearly flowing from developed markets to India is knowledge and skills as several industry leaders have pointed out to me.

So the argument here is as follows. Indian companies are already operating in a global environment where they access resources at best cost or location and then add value depending on where it makes most economic sense for a market that is most profitable or has consumption power. India may be that market, it may not be.

Given this construct, many globally thinking Indian companies are actually unprepared for a situation where one component of their global chain is exposed to or constrained by policies which are aimed at either managing or controlling prices - as is the case with steel prices. If it applies to steel, it will apply to any commodity whose market price is artificially held back.

Now this is the factual part of the argument. The moral is that price control is distortive and encourages consumption when it should be discouraged - oil prices being a case in point.

We also assume that the "aam admi" will not understand this equation. Actually, he understands it better than nuclear fuel deals. Finance Minister P Chidambaram admitted to me as much two weeks ago in an interview. "It's not that the common man will not understand, it's just that the common man will complain when prices go up," he smiled referring to LPG prices. Now that's not so much of a problem. The Indian polity is obviously used to much worse.