21 April 2011

Unhealthful News 111 - Black markets are just markets

This is mostly background, with just a bit of news.  It is relevant to yesterday's UN110 and an entry in our weekly reading list about THR, but did not really fit in either.

India recently banned the selling of "dip" products (sometimes incorrectly referred to as smokeless tobacco, but most of them are predominantly other plant matter, like betel nut, and other chemicals, rather than tobacco) in plastic pouches.  These single-serving products sold for the equivalent of a penny or two and seemed to be available on every block.  This odd new restriction could have been justified as a way to reduce litter, since those billions of little non-degradable wind-blown plastic pouches do make quite a mess.  But as I noted in UN64, proponents made it quite clear that this was a way to increase the cost of manufacturing and thus make these products too expensive for the "common people" (their phrase, not mine).  It is the Indian equivalent of location-specific smoking bans that supposedly have something to do with protecting nonsmokers, but are really just about making being a smoker less pleasant.

Like any supply-side intervention designed to reduce consumption, the plastic ban created a tension in the marketplace between the incentive to manufacture a desired product in the most efficient way, selling it for maximal profit in a free market, and obeying the rule.  The same principle actually applies to any regulation of a producer, such as pollution limits or rules against keeping employees chained to their work stations.  Purely from the perspective of making and consuming the good in question, it is more efficient for the manufacturer to ignore the rules.  The resulting efficiency gain from breaking the rules is split between the consumer (lower price) and producer (greater profit) in a proportion that is determined by some technical issues known as price elasticity, as well as whether others are obeying the rules.  I mention that last just to throw in an argument against those who suggest that producers decide how much profit they are going to make at consumers' expense; it is more accurate to say they take the best they can get, which is based on forces beyond their control.

Anyway, the most efficient way to impose a supply-side intervention to lower consumption is taxes, but it is not the only way.  Anything that raises the cost of supply, such as requiring expensive packaging or periodically imprisoning people in the supply chain, has a similar effect on price and thus demand, but at a much higher social cost.  If you impose a tax, the price increase is an efficient transfer – that is, everything that the consumer loses the government gains – so there is no net loss to total social wealth.  Whereas if you raise real production costs then the extra price paid by consumers is just burned up in by the higher costs, lost to the world.  Or to put in terms that would be better understood by a government official, taxes not only raise the price, but provide more money for the government, so are win-win (assuming raising the price really is a win, of course).

So why a ban on plastic packages?  Presumably the brains(?) behind the plastic package ban must have decided that imposing an equivalent tax would not work because the Indian government was not functional enough to enforce collection.  So, the fact that they chose to forgo taxation suggests they did not think they could enforce it, due to inefficiency, corruption, etc.  In some sense it is a clever solution:  It is quite difficult to figure out if taxes have been paid on a particular unit of product or if they are being collected at point of sale, but very easy to see if the cheaper plastic is being used.

But if that is the explanation, why, oh why, did they think that they could prevent some kind of black market from emerging?

Alternative markets are ways of taking advantage of the aforementioned tension and gap between the efficiency of unregulated competitive market and obeying all the rules.  The bigger the tension/gap, the more profitable and successful will be the black market in the absence of really intense enforcement efforts.  So since cannabis cannot be sold in stores, alternative supply chains spring up, with the higher-than-free-market prices reflecting the cost of occasionally being arrested or shot at, though the fact that prices are remarkably low means that enforcement is pretty ineffective.  High cigarette taxes create a enough of a gap between the free market and paying full price that there is room for both profit for the smugglers/counterfeiters and lower prices for consumers even though the illegal supply chain is much less efficient than those of the major legal manufacturers.  And even something as unexciting as taking Coke out of the vending machines in the city office buildings in Boston will inevitably result in some bored cubicle workers supplementing their income and helping out their neighbors by bringing in a cooler full to sell every day.

Anyway, my motivation for writing this explanation of markets in the face of prohibitions and partial prohibitions was just to give an excuse to quote this passage from The Times of India about how, sure enough, a black market in plastic packaged dip appeared almost immediately:
MUMBAI: The racket, involving the smuggling of gutka pouches into Maharashtra from neighbouring states like Gujarat to be sold here at thrice the actual price [emphasis added], continues unabated in the thriving black market.  The blackmarketeers are making huge profits by selling the banned gutka and pan masala sachets by charging three times the actual prices. One popular brand of gutka, whose MRP is Rs 4, is being sold for Rs 13, and another brand, whose MRP is Rs 7, is sold for Rs 20.
The rather vital fact that the reporter seems to not understand is that the actual price of something is whatever it is sold and bought for.  (Am I the only one who laughed out loud at that?  I am a bit afraid that I might have been.)  Yes, obviously we can just substitute "MSRP" or the "former price" for what he called actual price.  But I think there is more to this misunderstanding than mere incorrect wording in the national paper of record.  Factions in India keep talking about expanding the plastic ban to a complete ban on the products, thinking that would work out well.  But this story demonstrates that consumers are willing to pay at least triple the competitive market price for the product and, in a country with a lot of under-employed labor, that is undoubtedly enough of a gap to support a very nice black market.  A government that decided that it could not enforce a tax increase seems unlikely to be able to stop it.

There is nothing exotic or remarkable about this.  If those who have control over a market supply a lousy product or charge too much for it, or refuse to supply it at all, someone will step in.  That is the story of the market that gives us e-cigarettes (because pharma companies refused to produce a good cheap nicotine product), Firefox (because Internet Explorer was so lame), and crystal meth (because importing cocaine was made difficult).  You really have to wonder if the Indian government thinks it can succeed where Glaxo, McNeil, Microsoft, and the U.S. government failed.

[Coda: The examples in the last paragraph were chosen because they were cases where the previous products were creating huge fortunes while the entrepreneurs offering the alternatives have done ok, but have mostly earned only a workaday modest living through their efforts.  Market innovations like these often create a lot more surplus for consumer than for producers, Facebook and the question of whether meth is really good for anyone notwithstanding.]

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