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India’s Powerful Incentives

Aug 8, 2012 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Developing Economies, Economic History, Environment, Government, International Trade and Finance, Macroeconomic Measurement, Regulation, Thinking Economically, Uncategorized • 82 Views    No Comments

Imagine…

  • More than 500 trains suddenly stop.
  • More than 200 miners trapped underground.
  • No traffic lights.
  • Gridlock on many roads.
  • No ATMs.
  • Irrigation systems halted.

 

On July 31, a massive blackout struck more than half of India. Affecting 600 million people, the outage struck 10% of the earth’s population. I suspect the calamity was all about bad incentives.

Have you heard of Coal India? The source of most of India’s power supply, Coal India is a state controlled monopoly that was recently privatized. Still though, with only 10% of its shares privately held, Coal India is told by government to charge artificially low prices. As a government entity, it has had little incentive to feed more coal to a growing economy.

At the other end of the power supply chain are grid companies that are controlled by regional governments. Hoping to make their electorate happy, the politicians who oversee the grid companies have the incentive to provide free or subsidized electricity to 1/3 of their customers, especially in rural communities. This year, when farmers needed extra irrigation because of insufficient rainfall, with no price constraint, they had the incentive to demand much more power to water their fields.

Meanwhile, in the middle, between Coal India and the grid companies are the privately owned power companies that produce electricity. They can’t get enough coal from Coal India nor enough revenue from the grid companies. As a result, they have insufficient incentive to invest in new capital.

Then add to all of this the factories and individuals who experience power outages daily. Anyone who can afford it has the incentive to purchase backup generators and batteries instead of using the money more productively.

Do you think that the massive power shutdown will change these perverse incentives on the demand and supply sides of India’s electricity markets?

The articles that describe India’s blackout and its problematic generating system are here, here and here. Also, this 5 minute Economist podcast/video concisely described the problems and their impact.

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