Karnataka’s ore problem: Distortions in price and quantities injecting inefficiency into important sectors of the economy

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Updated: Nov 17, 2018 1:30 AM

These distortions in price and quantities are a recipe for injecting chronic inefficiency into important sectors of the economy, like iron ore and steel.

The real cause for worry is that this isn’t simply about the miners of Karnataka or the state of Karnataka.

Free markets have a logic, and rules. Free markets cannot be a free for all just as ease of doing business cannot cross the line of legality. Some years ago, some sections of Karnataka’s iron ore mining industry had blurred the lines, destroyed the logic and tarred the perception of business. If not the state, then the courts were bound to clamp down on illegal mining. The illegality wasn’t simply about not obtaining necessary permissions but also about avoiding taxes and royalties. Correctives were necessary but have they inadvertently ended up tying in knots the legitimate iron ore mining industry? More importantly, is the cause of economic efficiency being compromised?

Consider the state of play in the iron ore industry in Karnataka. There are court-imposed quantitative restrictions on production. Between 2013 and 2017, the cap was set at 30 million tonnes per year. Subsequently, it was relaxed to 35 million tonnes. Estimates suggest that the true potential could be up to 60 million tonnes. India’s long pre-1991 history of fixing quantities of goods to be produced across the economy led to poor economic outcomes. Administrators or courts, even with the best intentions, are not the best judge of what is the right quantity to be produced or mined, the forces of supply and demand are. The “right” amount may well be less than 35 million ore anywhere up to full potential.
The restrictions carry on. Export of iron ore from the state of Karnataka is banned. In fact, miners must sell the ore within the state of Karnataka. Further still, they must sell iron ore only to final consumers (i.e., steel mills) and not to traders. These measures would seriously limit the ability of sellers of iron ore to negotiate a fair price. But in a directive that almost completely kills the market, the ore must be sold via an e-auction only, although a transparent market mechanism cannot work properly when the number of participants is restricted by fiat. The problem with administrative decision making on what are business or market matters is that supply and demand rarely tally. In the case of Karnataka, the buyers of iron ore, i.e, the steel industry, have no restrictions on where they purchase their raw material from. They are allowed to buy from Karnataka, the rest of India, and if they like, from abroad via imports. Unsurprisingly, the locally produced iron ore is not entirely sold and the seller has no avenues to offload inventory.

The real cause for worry is that this isn’t simply about the miners of Karnataka or the state of Karnataka. If the negative outcomes are restricted to a handful of companies and bigger gains accrue to the economy, then it could be argued that the measures are justified. However, the consequences for these distortions in price and quantities have severe economic consequences for the economy as a whole. They are a recipe for injecting chronic inefficiency into important sectors of the economy, like iron ore and steel, which are critical to power India’s rising growth trajectory. Already, all mining, including that of iron ore, is banned in the neighbouring state of Goa, because of lacunae in the lease renewal processes. If Karnataka’s miners cut back production because of the incentive structure they face, India will lose domestic supply which will eventually be made up by imports. Given the already bloated import bill because of oil, gold, coal and other minerals, India cannot afford to create any more artificial scarcities, thereby putting avoidable pressure on the macroeconomy and the rupee. Given the external sector stress, the argument in favour of promoting exports should apply to Karnataka’s iron ore too.
There is an impact at the microeconomic level too. By distorting the prices and availability of a key input, the final consuming industry, i.e., steel, is also being injected with some amount of inefficiency. Steel is used as an input in other industries so the inefficiency would cascade. Ultimately, ordinary consumers pay a higher price in this less efficient outcome.

None of this means that the government or courts should allow a free for all with rampant illegality. However, it is important to distinguish between regulation and control. Mining needs regulation which will ensure compliance with the law, maintenance of standards and preservation of the environment. But that does not require caps on production or a bar on freedom of marketing. Most modern sectors of the economy have independent regulators who supervise without controlling. They are empowered to come down hard on illegality without punishing those running their business in compliance with the laws and rules. Mining needs something similar. Ultimately, a free market works best when it is regulated and where there is a level playing field for all competitors. Perhaps a pilot experiment could begin in Karnataka.

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