It’s hard to judge the airfare issue: Financial Express 11th Dcember 2010

The recent controversy on government intervention relating to airfares raises a broader question for us: how free are the markets in a deregulated set-up? The issue comes up since while deregulation has meant less direct intervention, there is a strong feeling that oligopolistic power is being exercised by market participants, especially when it is a sellers’ market. This has led to a reversal of stance by the government through selective intervention, either directly or through innuendo.

Let’s see the situation today. We have government intervention when airlines have jacked up their fares. Microfinance institutions have been under the scanner for charging higher interest rates while some time back, mutual funds came under pressure to terminate their commissions paid to the brokers. Banks are being told regularly to keep rates low for industry while high commodity prices have been frowned upon through invocation of the Essential Commodities Act and the ban on futures trading, even when supplies have played truant. Insurance companies have been subjected to a series of regulations on their Ulip schemes. Are we being averse to market play or is there something amiss in our markets?

Ever since we embarked on liberalisation in 1991-92, we have opened up sectors but been reluctant to let the market decide the prices. Further, the measures have been half-hearted as we are not willing to go back fully to the price control days. The airline issue is quite straightforward. The airlines are making losses and decided to increase their fares to improve profitability. The rationale is that if people are willing to pay, so be it. Normally, around 60-80% of the travel is on business account, and hence does not really make a difference.

If people don’t want to pay, they need not travel; and lower sales will automatically bring down airfares as the utilisation rate comes down and hence fares would be mean-reverting. Air travel, it must be remembered, cannot be treated as an essential service like, say, the railways; as in the past, when rates were high, few travelled and no one complained about high rates. Besides, today, with airports being renovated and user charges being heaped on the customers, no one has complained about tripling of charges on all services from parking to catering in these airports. Also, an anomaly is that if one looks at the total price paid on a ticket, the fare is less than the other fees and charges; and interestingly, the latter is not being questioned as it flows to other government entities.

At the broader level should players have the right to set their prices? A market works on the principle of there being a large number of buyers and sellers. Here no one influences the other’s decisions, and the solution is optimal. The problem is that in real life such markets are rare, as they tend to move towards an oligopolistic structure, given that infrastructure cannot afford to have many players. Therefore, we have a set of, say, 10 (airlines)-50 (banks) players that sell products to consumers. These services cannot unequivocally be called ‘essential’. Some services that require high overheads tend to be loss-making, and are on the lookout to increase their charges. When it is a government service, it is understood that losses are part of social expenditure. But when it is private, then the issue gets tricky.

Now, there are several user charges that have been raised as far as individuals are concerned, which can be said to be the result of near monopoly power. These include electricity and water charges, petro-products, MSPs (for farm products), milk, etc, where the prices keep increasing but are accepted as being non-exploiting. The question is, why should airlines be singled out?

In a free society, ideally, markets should be allowed to determine prices. When the market is supreme, cartels will not work when it comes to non-essential products and services as the customers have a choice not to use it. This becomes critical when it is an essential service, where regulation is called for. For essential services, there has to be a price ceiling, but then private operators would be less enthusiastic in case they are not remunerative.

However, a lacuna is the opacity of the pricing systems in all such services. Websites are rarely transparent and complicate matters. This has to be addressed and service providers should be asked to present the same in a rudimentary fashion. Today, the transparency in financial markets is through the fine-print, which is difficult both to read and understand.

At another level, in the case of the airlines, if the government is really keen on ensuring sanity in prices, it should have its own carrier offer the lowest rates to bring down prices of other airlines. That would really set an example for others.