Politics of Arbitrage

The Concise Oxford Dictionary defines arbitrage as ‘the buying and selling of stocks or bills of exchange to take advantage of varying prices in different markets’. Politics, among other things, are the ‘activities concerned with the acquisition or exercise of authority or government’.

Two painful events – the brutal murder of Manjunath, a bright, young, upright IOC Sales Officer, by the Diesel adulteration mafia, and the expose of several Members of Parliament demanding and accepting money for asking questions in the House – have demonstrated how arbitrage has taken a hold over our politics and state-controlled business. In many ways, both events are linked, and lay bare the distorted incentives in politics and the grievous consequences the nation faces.

Let us take the Manjunath murder. Behind the tragedy and crime lie profiteering, dangerous fusion of crime with business in some sectors, political patronage in creating commercial opportunities, and the perverse role of the state. The proximate cause of Manjunath’s death may be the bullets fired by a gangster-businessman who wanted to eliminate an incorruptible official who would not tolerate adulteration of diesel with kerosene. But the real causes are more complex. First, for decades, oil dealerships have been awarded in most cases for a price, or as patronage. The state had monopoly, and ministers and their cronies converted their opportunity into profit. Second, once the dealer paid hefty bribes, he expected decent returns. But given administered pricing distorting markets and competition, the margins were inadequate to meet the hidden costs including the haftas paid to many inspectors – vigilence, weights and measures, civil supplies etc.

Third, in our anxiety to help the poor, wrong policy choices are made. Instead of providing direct subsidies through coupons or other means, price subsidies are offered on kerosene. In fact, kerosene consumption is not growing as fast as that of petrol or HSD. From 1984 to 2004, petrol consumption increased from 2.1 million tones (mt) to 8.3 mt (300%); and HSD consumption from 13.7 mt to 39.7 mt (200%); kerosene consumption increased more modestly, from 6 mt to 9.4 mt (57%). Clearly, the fuel and lighting needs of the poor are met by other fuels. And yet, vast subsidies are given in the name of the poor.

Fourth, as oil dealerships are obtained through patronage and bribery, and as margins in honest business are slim, dealers indulge in short-delivery and adulteration with subsidized kerosene. 5-10% short delivery by tampering the meters in connivance with the legal metrology officials was very common a decade ago. Lok Satta volunteers successfully stopped short delivery in 1998 by a simple technique of demanding filling of a calibrated can of known volume, instead of the fuel tank of the vehicle. This exposed short delivery, and within a fortnight the meters were set right in all the 1500 petrol stations in Andhra Pradesh, and random checks by volunteers made it sustainable. Eventually, oil companies acted with vigour and substantially reduced short delivery all over the country. But given the other compulsions of huge bribes for dealership and regular ‘rents’ paid to state officials, the demand for illegal profits was undiminished. This profiteering is made possible by adulteration of diesel with subsidized kerosene. Short delivery can be stopped by citizen assertion, but adulteration can only be suspected by using a hydrometer to measure density, and can be proved by chemical examination. The citizens are not empowered to measure density, and results of chemical analysis constitute evidence only when the samples are taken by competent authorities in the prescribed manner, and tests are conducted in authorized laboratories. Therefore proving adulteration demands great integrity and perseverance, not to speak of efficiency and fairness in the whole process, on the part of officials.

Finally, this whole causal chain led to a system of rent seeking everywhere. Public money was wasted on subsidies which never reached the poor; dealers who purchased their licenses through huge bribes fully exploited the arbitrage opportunities, and an organized system of rent-seeking was established. In this vicious cycle of corruption, most players were helpless to resist the system, as the price paid for resistance far exceeds the benefit. Manjunath payed the ultimate price.

The money-for-questions scandal is a more straight forward case of arbitrage. But the nature of our politics and the demands made by the political system are at the root of the problem. In our electoral system, the marginal vote that a candidate obtains is the difference between victory and defeat. Candidates therefore spend vast amounts, mostly illegitimately to buy the vote, bribe officials and hire muscle men to browbeat the voters. Large, illegitimate expenditure does not guarantee victory, but modest, legitimate expenditure almost certainly guarantees defeat! Trapped in this vicious cycle, candidates overspend, and once elected, need multiple returns on investment to sustain the system. Given the control over levers of state, politics is seen as an arbitrage opportunity. Money is made mostly by transfers, contracts and interference in crime investigation. MP LADS and other such direct access to state resources are rent-seeking opportunities. In general, influence peddling in decision making in government is financially very rewarding for legislators. The more desperate legislators seek money for questions.

In any system, there are always a few black sheep. But the political crisis in India is much deeper, and cannot be resolved merely by fiery denouncements and a few expulsions. Parliament and parties should wake up, and transform current politics as business and arbitrage by reforming our electoral system and eliminating the distorted incentives. We need to herald a new political culture, and make honesty compatible with politics and power.