Jan 31, 2019

Understanding beef-ban, prohibition and prostitution in India through repugnant market theory

Featured post on IndiBlogger, the biggest community of Indian Bloggers
Bans are not always effective as we know. Gujarat's prohibition has lead to a thriving black market for liquor, whereas the ban on prostitution has held up relatively well in India with only a small steady state black market that has not grown bigger. Selling and consumption of beef on the other hand, where banned, has been effective to a large extent - to the determent of the health of cattle and leather industry - as was witnessed during recent ban on cow slaughter in Uttar Pradesh.

Bans are always blunt instruments. It is necessary for a public policymaker to study the effects from the prism of effectiveness of achieving policy objectives of a ban, over the negative externalities, and also lack of effectiveness arising due to administration issues. It is not that a stiffer punishment would automatically lead to desired outcome. To cite an extreme example, rape in India attracts imprisonment of 7 to 10 years. Murder attracts life term or hanging. If the punishment of rape is increased to life term or hanging, as was being mooted in media for cases of child rape, it might lead to adverse result where the rapist kills the victim as the punishment doesn't increase by the additional act of murder, whereas the killing of victim may eliminate the witness!

Such analysis may be grown rigorously. An interesting recent paper tackles such questions from a game theory point of view for market of repugnant transactions. Co-written by the noble prize winning author Alvin Roth of Stanford, it tries to measure repugnancy along two dimensions of extent and intensity and tries to predict the outcome of banned activities with certain assumptions on initial conditions and progress. In the words of the paper:

This paper proposes a simple, stylized theoretical model to help understand why some transactions can be effectively eliminated by legally banning them, while others are more resistant, to the point that they may be impossible to extinguish or even suppress to low levels, so that it might be wise to consider different goals for dealing with them.

The paper takes the example of drug market to develop the analysis. However, the results generally hold good across various examples including prostitution, banned meat trade and so on. An interesting result along the way is that the existence of a market before banning plays a role in the effectiveness of the ban subsequently. In the words of the authors: 

...Before beginning the analysis, consider how policy makers could have some control over the initial states. One example would be the regulation of synthetic drugs. When a new synthetic drug becomes available, it takes time before it can be banned. The number of users it attracts before it is banned may be an important factor for the prospects of extinguishing the market. So the speed of initial regulation may be consequential, and there may be markets that could be successfully prevented only by prompt action, and not when they have become well established...

I quote some of the analysis and results below: 


...if the market is insufficiently repugnant in extent or intensity, even substantial legal penalties “on the books” may be insufficient to deter participation if those penalties cannot gain enough social support to be reliably enforced. Note also that if the feasible punishment is not too large, and if the extent of repugnance among the population is low, then even the maximum intensity of repugnance among those who wish to ban the market may be insufficient to control the blackmarket. And as an illegal market becomes larger, it becomes more likely that those who wish to participate in it can do so without encountering those who would penalize them. Consequently, black markets that have operated successfully for a long time become increasingly hard to eliminate if the underlying social parameters and legal punishments cannot be changed.


But changing social repugnance, and even increasing legal punishments in an ef- fective way, may be difficult. Policy makers may be able to influence the extent or intensity of repugnance by education and public relations. But because legislators don’t have easy or direct access to who feels how much repugnance, this is not likely to be anywhere near as easy as passing legislation. At the very least, chang- ing widespread attitudes takes time. And increasing mandated punishments beyond what social repugnance will support can be counterproductive if it makes citizens less likely to report illegal transactions and juries less likely to convict.  So we may never be able to completely eliminate some markets, despite the fact that they cause considerable harm. Hence harm reduction should be in our portfolio of design tools for dealing with repugnant markets that we can’t extinguish despite the harm they may do.


Therein lies the lesson for a public policymaker. 

Jan 8, 2019

GVCs and the tariffs - a simple fact the free traders miss

A common argument of free trade supporters runs this way:
  1. Tariffs create barriers to movement of goods - India has high tariffs on various goods 
  2. Global Value Chains(GVCs) operate better with low barriers for movement of goods
  3. Therefore high tariffs are responsible for India's lack of integration into various GVCs
In principle the argument is correct.  For a graduate student who has completed a course on International Economics, the above argument is obvious. This belief carries over to the practising economists, and journalists who consult the economists. That's why we read a lot of criticism of the government when tariffs are raised - as they lead to breaking away from GVCs, or rather in India's case, not getting integrated into them.
A simple case where a duty of 10% is levied every time a component crosses the border in the journey through the value chain, where a value addition of 30% takes place at each step, leads to a situation where the prices build up pretty fast as can be seen in figure below. Starting with an initial value of 100, the component start showing significant difference in price by the time it crosses a dutiable border the third time, showing that a country with even a 10% duty at border becomes a drag in the value chain, and is liable to be opted out of the chain. Thus the logic holds.

image of GVC value chain tariff duty competitiveness
Effect of duty cascades with each border crossing making the duty levying participant uncompetitive in GVC

In practise the above argument is not as parsimonous. The argued tariff effect on GVC participation is exaggerated. Lest I be misunderstood, let me state here that high tariffs are always a blunt instrument to use and I am not a supporter of blanket high tariffs on goods, especially the ones that are part of GVCs.  However, the argument that tariffs at the border are sole reason for India not getting into GVCs is flawed. Here's why.

India, and most other countries, work under the principle that "Goods are exported, taxes and duties are not" when it comes to exports. One may call it by various names ranging from 'zero rating of exports' to 'duty nullification schemes', but the fact remains that policy practitioners all around the world understand this problem and devise means to counter this effect when it comes to goods that are re-exported with/without value addition. Such schemes also do NOT run counter to the Agreement on Subsidies and Countervailing Measures (ASCM) at WTO.

India has mainly three ways of handling such border crossings without penalising the imports that are meant for GVCs/re-export with/without value addition -
a) Advance authorisation scheme - a popular duty nullification scheme where duties are not collected at border with an assurance of re-export of goods with a minimum value addition of 15%
b) Duty free import authorisation scheme - same as above with a value addition of 20%
c) Dedicated duty free enclaves such as Special Economic Zones and bonded manufacturing zones such as EOUs.
I am aware of such schemes being run in many countries and there can't be any objection of these schemes at WTO. In addition, India also enters frequently into various trade agreements with partners where duty free access is provided.

I consider the non-tariff barriers (NTBs) more important than tariff measures which are countered through these schemes. In addition to NTBs, India also suffers from relatively poor infrastructure, longer distance and hence travel times, poor investment in industries, and lack of economies of scale in manufacturing sectors where GVCs are prevalent (e.g. electronics/semiconductors) and such other factors that matter more in GVCs than a simple border tax that the free trade theorists abhor.

The above needs to be kept in mind when we argue against a mere border tax effecting our chances at participating in GVCs. 


Excel workbook for the above picture is attached for reference below: