Thoughts on Governments in Business, Schumpeter and Bailouts

A modern state is often required and expected to ensure the establishment of relations between the Government and Business. It is the interaction of these two agents that results in economic progress or economic disaster. However, what exactly should be the level and extension of this relationship? Should the relationship be symbiotic or should be one of active disinterest?

Active disinterest should not be interpreted as a laissez-faire affair but simply a situation of regulation without the government entering the market as a player. The reasons that have created and encouraged this thought process are the results of the misfired attempts of the Government of India to try to influence the market or rather play an active role in the market or to attempt to perform the functions of the market. There are two areas which can be studied to draw arguments in order to understand this entire thought process.

1)      The Airline Industry in India as a Government dominion

2)      The Airline Industry in India after entry of Private Players

The Airline Industry in India is currently said to be struggling and among the many other factors, one of the major factors is the interference of the government in the airline business. Air India stands as an example of the difference between the management strategies of the Government and the private sector. The management of a service is often the primary cause of differences in earnings of two different firms for the same services. Another aspect that needs to be mentioned is that Government’s have rarely entered a market with the idea of making profits at least till now. Thus, Government’s often have little appetite for innovation especially if there is a probability of innovation putting into motions conditions required for a Schumpeterian Creative-Destruction possibility.

During the research for this topic a professor was contacted who mentioned that the airline industry in India had experienced the exact opposite of Creative-Destruction. Destructive-Creation.

Creative-Destruction implies that creativity preceded the destruction and it was the introduction of this new idea that resulted in the older versions of that idea or complementary idea being eliminated from the market as they have lost their efficiency. In India, the Government had established a near perfect monopoly over air travel by operating Air India/Indian Airlines. Monopolies often set into place a standardised management protocol with little room for change and thus when private investment was suddenly allowed into the airline industry, the Government enterprise couldn’t keep pace.

The “pent up” investment potential for the airline industry when suddenly unshackled resulted in the Government enterprise starting to fail as a ‘swarm-like’ clustering scenario suddenly emerged in the airline industry i.e. multiple players entered the industry. Thus, destruction was in progress.

With the entry of multiple profit desiring players into the industry, there was a race for better innovation and hence emerged the era of TV, wi-fi etc in flight. Thus, innovations started taking place and hence, the idea of Destructive-Creation emerged.

According to a theory, in the short run even if multiple or all the firms in an industry end up with sub-normal profits, in the long run, the inefficient firms will exit the market and their market share will be transferred to the more efficient firms, thus the remaining firms in the industry will end up with normal profits.

The idea behind this theory is fairly simple and rational. It is based on the premise that with a lot of competition, the Marginal Revenue (revenue for every extra unit sold) is likely to be less than when there is limited competition. Thus, the Total Revenue of the firm will be low if there is competition as the costs will increase due to increase in budgets of advertising, discounts and even to an extent researching the next big innovation. However in the long run, as the inefficient firms exit the market, the market share for the remaining firms will increase and thus resulting in an increase in the Marginal and Total Revenue along with a reduction in costs as advertisements and discounts can be toned down. The budget for research will remain constant in such a situation if not increase as every innovation has in it the potential to change the layout of an industry.

Applying this idea to the Indian Airline Industry, it should be noticed that inefficient firms (Kingfisher) have started making moves towards exiting the industry while the more efficient firms continue to survive and even post an occasional if not periodically continuous profit. There is little need to worry about the fate of the Indian Airline Industry as the market will never miss a potential opportunity to earn profits (engage in economic transactions). Hence, the void will always be filled by the markets if one is even allowed to exist.

This essay concludes with the question of whether to fund inefficient firms like Air India and King Fisher. Should they be given a bailout? Post the understanding of the theories mentioned here, the idea of a bailing out companies fails to invoke any enthusiasm (especially when they are not too big to fail). Bailing out firms in an industry that is set to become healthier with their departure to save a few jobs is unsettling as such a bailout has the potential to jeopardise the growth prospects of the entire industry and in the long run will harm many more jobs than that it would save in the short run.

Therefore after having mentioned the way a government functions and the way the markets functions it can only be said that the markets are best left to themselves. The poor management of a firm by the Government ensures that the industry continues to face the troubles it is currently facing while the dynamic interactions that occur within the market ensure that in the long run the industry reaches a point of equilibrium and stability. Hence, Governments ought to only regulate them so as to ensure equality of opportunity and law for all.

In Economics, saving the future in the short run often accounts to damaging the future in the long run.

 About the Author

picDhruva Mathur

Dhruva is a 20 year old fresh graduate from St. Xavier’s College, Mumbai with Majors in Economics and Political Science. He blogs at An Indian Youngster  and tweets at @Dhruva_Mathur and is followed by Kevin Rudd, Foreign Affairs and European Council on Foreign Relations among others. In his spare time, he enjoys reading and debating. He is a Social Liberal with a Right tilt for economics oriented towards development.

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