A Market Failure Framework for Evaluating Public Sector Undertakings

by Arjun Krishnan.

Commentators and investors often judge companies, including state-owned firms, by their profitability. While profit is a useful metric for private firms focused on generating returns for owners, applying the same standard to state-owned enterprises is problematic. Many lament that India's Public Sector Undertakings (PSUs) incur losses, assuming that losses signal failure and profits signal success. However, this assumption misjudges the real purpose of PSUs. Although some evaluation frameworks expand beyond profit, few explicitly align performance criteria with the specific market failure that the enterprise was established to address. This article argues that assessing PSUs solely on profitability is misguided, and their success should be measured by how well they address the public purpose for which they were created.

This article proposes a two-part framework for evaluating PSUs. The first part poses an ex-ante question about purpose. A PSU is justified only when it aims to correct a market failure that less intrusive instruments cannot correct. The second part poses an ex-post question about performance. Evaluators should then judge a justified PSU on two dimensions: efficiency and effectiveness. Efficiency measures how productively an enterprise converts resources into outputs. Effectiveness captures whether the PSU actually corrects the failure it was created to address. Balance sheets cannot serve as a reliable proxy for either dimension on their own.

Ex-ante: when is a PSU justified?

The justification for any PSU must begin with market failure. When markets function well, they allocate resources efficiently, and the state has no grounds to intervene. Economists identify four situations where markets fail to do so. First, externalities arise when a cost or benefit of an economic activity falls on an unrelated third party. Positive externalities lead to underprovision, and negative externalities to overproduction. Second, public goods are non-excludable and non-rivalrous. Firms cannot easily charge users, and private markets typically underprovide them. Third, information asymmetry occurs when one party to a transaction knows more than the other, distorting decisions and reducing market efficiency. Fourth, market power arises when limited competition allows firms to raise prices or restrict output below socially optimal levels.

A market failure on its own does not justify a PSU. There are three additional tests. First, scale: how many people are affected, and by how much? A localised information asymmetry in a niche market is different from one that excludes millions from credit. Second, persistence: is the failure temporary and self-correcting, or structurally durable? Markets sometimes endogenously mitigate their own failures through competition, reputation, or contracting. Exogenous forces such as technological innovation or institutional adaptation can have the same effect. Non-state mechanisms such as industry associations, cooperatives, or third-party certifiers may emerge to address coordination problems or information asymmetries without government ownership. Even classical public-good cases have been addressed without state ownership. Coase's (1974) account of English lighthouses is a canonical illustration: what was treated in classical economics as a pure public good requiring state provision was, in fact, supplied for centuries by Trinity House, a private body that collected dues from ships at port. The presence of such adaptive mechanisms weakens the case for a PSU. By contrast, failures that persist despite opportunities for institutional adaptation present a stronger case for public intervention.

Even when a market failure is large-scale and persistent, the state has many ways to respond. The third test, then, is instrument choice: Is ownership the right way to address this failure? The state can regulate, tax, subsidise, or contract with private providers. Ownership is one of the most costly options. Ownership exposes the exchequer to operating losses, creates a vehicle vulnerable to political capture, and softens the budget constraint in ways regulation and subsidy do not. The case for ownership has weakened with experience. Publicly owned natural monopolies in many sectors turned out to deliver less output for a given level of inputs than the textbook treatment had suggested. Regulatory practice has grown more sophisticated, with sector-specific knowledge and administrative law tools that did not exist when many PSUs were created. Public-private partnerships have further narrowed the cases for state ownership, with private firms providing goods and services under contracts that set market structure, pricing, and quality. For every PSU, the central question is why the problem could not be addressed through one of these alternatives.

India operates 291 Central Public Sector Enterprises across sectors as varied as petroleum refining, power transmission, hotel management, and defence manufacturing. The policy debate about this universe has been conducted in terms of profitability. How many are loss-making? What do aggregate losses cost the exchequer? These questions are downstream of a prior one: which market failure, if any, justifies each enterprise. Those that address no market failure have no business existing and should be sold off to buyers or wound down, with assets liquidated. Those that aim to correct a market failure face a harder question: how well do they perform in addressing the failure they are expected to correct?

Ex-post: efficiency and effectiveness

Two questions emerge for judging how well a PSU is performing. The first is efficiency. Efficiency is the ability to derive the greatest possible output from a given quantity of financial, physical, and human resources. The second is effectiveness. Since a PSU is justified only for market failures, we need to evaluate whether it, in fact, corrects the failure it was created to address. A PSU can be efficient at producing what a competitive market would produce anyway, or effective at reaching its target population at three times the cost a regulated private operator would charge. Both outcomes are undesirable. In the first case, the PSU adds little social value. In the second, it imposes unnecessary costs to achieve a legitimate public objective.

Experience with direct public provision over the last half-century has weakened the case for PSUs on efficiency grounds. Publicly owned natural monopolies in many sectors exhibited poor x-efficiency, producing less output for a unit of input than private firms. The Ministry of Road Transport and Highways reports that the revenue-to-cost ratio for the 58 reporting undertakings fell to 63.6% in 2021-22, that state cabinets blocked fare revisions, and that the resulting losses reached Rs 30,192 crore in aggregate. The mobility problem the SRTUs were created to address is real, but the case for state ownership of the operator is much weaker than the case for state involvement in the sector through options like subsidies.

The regulatory and contracting alternatives to ownership have grown more capable over the same decades. The regulatory state now possesses sector-specific tariff and quality regulation, administrative law procedures for rule-making, and incentive-compatible contracting techniques (Laffont and Tirole, 1993). Public-Private Partnership (PPP) models have spread across sectors once considered the natural home of direct provision. Iossa and Martimort (2015) show that bundling construction and operation into a PPP can be efficient when build quality materially lowers operating costs. This structure is common in roads, water systems, and many public utilities. Even classical public goods, including urban streets and water supply, are now routinely constructed and operated through PPP agreements that specify quality and pricing. The Government of India's disinvestment policy lists market imperfections and public purpose as criteria for retaining a PSU in public hands. The government excludes profitability as a criterion.

For certain types of goods, state ownership may be the preferable option. When contract terms cannot specify aspects such as quality, the case for ownership over contracting strengthens (Hart, Shleifer, and Vishny, 1997). A private operator paid to deliver an output will cut costs along whatever margins the contract leaves unspecified. Where quality is one of those margins, the cost saving comes at the consumer's expense. A private prison contractor's contract may specify calorie counts and dietary variety, but regulating food quality or taste may prove impossible. These savings flow to the contractor while the welfare loss falls on inmates. Direct public ownership is preferable in such settings precisely because the public manager's weaker incentive to cut costs leaves the unspecified quality dimensions intact.

In addition to efficiency, effectiveness needs to be judged. Effectiveness measures whether the PSU is correcting the market failure it was created to address. To illustrate the difference, consider a state-owned bus operator tasked with providing transport connectivity to remote rural areas. An efficient operator minimises the resources needed to run the service. An effective operator ensures that the targeted rural communities are actually connected. A PSU may succeed on one dimension while failing on the other.

The effectiveness criteria take different forms across failure types because the welfare yardstick differs. The market power row needs some additional explanation. A monopolist with declining average costs cannot price at marginal cost without losses. Ramsey-Boiteux pricing sets the loss-minimising alternative: markups above marginal cost should rise as demand elasticity falls, placing the heaviest charges on users whose consumption is least price-sensitive. A markup on inelastic demand reduces output the least and destroys the least surplus per rupee of revenue. A political cross-subsidy structure follows a different logic, allocating markups across user groups by political weight rather than by elasticity. The effectiveness test for a PSU that disciplines market power, therefore, asks whether its markup structure approximates Ramsey-Boiteux rather than political cross-subsidy.

Table 1 sets out the effectiveness criterion for each market failure, with the less intrusive instrument serving as the comparator.

Table 1: Effectiveness criteria for PSUs by type of market failure

Market failure	Market problem	Role of PSU	Effectiveness criterion	Less intrusive instrument
Externalities (positive)	Producers cannot capture the full social benefit, so the private market undersupplies relative to the social optimum.	Produce at a level that accounts for spillovers private producers ignore, or finance investments whose social returns exceed appropriable private returns.	Is the targeted output being delivered, and is the additional supply above the private optimum sufficient to close the externality gap?	Production subsidies, tax credits, intellectual property protection, advance market commitments.
Externalities (negative)	Private producers impose costs on third parties they do not bear, so the market overproduces relative to the social optimum.	Produce at a level that internalises external costs private producers would otherwise externalise.	Has the targeted reduction in harm been achieved, and are emissions per unit of output below the unregulated counterfactual?	Pigouvian tax, tradable permits, command regulation.
Public goods	Private producers cannot exclude users from a non-rivalrous good, so the market undersupplies or fails to supply.	Provide the good where private cost recovery is impossible or inefficient.	Is the service reaching the target population, and is coverage approaching the welfare-maximising level?	Contracting with private providers under a public service obligation.
Information asymmetry (seller knows more)	Private sellers hold information about quality that buyers cannot observe, so low-quality goods crowd out high-quality ones.	Enter the market and disclose costs, quality, and pricing as a benchmark that private sellers would otherwise suppress.	Has the PSU's presence made quality observable to buyers and sustained transactions that would otherwise have unravelled?	Mandatory disclosure regulation, third-party certification, independent benchmarking authority.
Information asymmetry (buyer knows more)	Buyers hold private information about themselves that sellers cannot verify. Sellers respond by raising prices, rationing, or withdrawing supply.	Offer service to groups private firms avoid because they cannot distinguish high-risk from low-risk customers.	Is the PSU enrolling the high-risk groups private markets exclude, and is the share of high-risk individuals covered higher than under the private counterfactual?	Risk-pooling mandates, mandatory insurance schemes.
Market power	Private firms price above competitive levels or restrict output below the social optimum.	Compete to discipline private pricing. In a natural-monopoly case, price at the welfare-optimal level.	Is the PSU pricing closer to marginal cost than an unregulated monopolist would, and does the markup structure approximate Ramsey-Boiteux rather than political cross-subsidy?	Competition law and antitrust enforcement, sectoral price regulation, separation of monopoly network from competitive services.

A PSU can fail on either dimension or both, and each case calls for a different response. A state-owned bus operator that abandons remote routes for crowded urban corridors is efficiently delivering something the market can deliver. Efficient delivery of a service that the market would have provided is no justification for state ownership. A PSU that effectively corrects a market failure but does so at an unjustified cost may generate more welfare loss through waste than welfare gain from correcting the failure. Reform or contracting out may be the appropriate response.

Soft budget constraints

PSUs operate under what Kornai (1998) called a soft budget constraint. A private firm that runs at a persistent loss is likely to go bankrupt. A PSU does not, because the PSU expects the state to cover the shortfall. The expectation of rescue weakens the discipline that revenues and costs would otherwise impose on managers.

A PSU pursuing a legitimate mandate should not show sustained accounting losses on its own books. Where pricing reflects deliberate policy, including selling output below cost for welfare reasons, the resulting deficit is a transfer from the treasury to the consumer. The right place for that transfer is the government's expenditure account, recorded as an explicit subsidy and matched by income on the PSU's accounts. Accounting separation keeps the cost of social policy visible in the budget, where parliamentarians can scrutinise it, rather than in an enterprise's operating accounts.

The Food Corporation of India illustrates what happens when this discipline breaks down. The Corporation procures grain at minimum support prices set by the Cabinet, stores it, and supplies it to ration shops at prices well below procurement cost. The shortfall is intended to be transferred to FCI as a food subsidy from the union budget. However, for long stretches, the government did not transfer the full subsidy in time, and FCI raised debt, much of it from the National Small Savings Fund, to bridge the gap. This practice was especially prevalent between 2016 and 2021. The losses that appeared on FCI's books reflected the failure to transfer the subsidy on time. The government used FCI's balance sheet to delay recognition of expenditure that should have appeared in the budget.

The existence of PSUs can then soften budget constraints in two ways. First, if a PSU knows it can rely on transfers from the treasury to cover any shortfall, its managers have less incentive to contain costs than managers of a private firm would. As a result, the PSU's budget constraint is softened. Second, PSUs like FCI soften the budget constraint of the government that created them. Since the enterprise absorbs costs that should have appeared in the budget, the state's social spending is understated. Once this practice exists, the headline profit or loss of a PSU carries less information. A loss-making PSU may be one that delivered the mandate but did not receive the subsidy. A loss-making PSU may also be wasteful. Which case applies cannot be understood based on the profit and loss account. Persistent losses on a PSU's books are therefore a useful diagnostic. They suggest either operational inefficiency or off-budget accounting through the PSU's balance sheet.

The framework, so far, treats PSUs as faithfully pursuing their mandates. They often do not. Even an enterprise with a legitimate market failure justification is run by people with their own interests. Governments are themselves made up of self-interested actors, and political objectives can capture an enterprise created to address a market failure. These government failures show up in the performance criteria above: prices far from welfare-optimal levels, investments that do not deliver the promised social benefits, or operations that consume more inputs than the next-best instrument would have required.

Government failure also shapes how the state manages exit from enterprises that have outlived their justification. A framework that identifies when a PSU has no reason to exist is useful only if exit decisions follow honestly from that assessment. Chakrabarty (2023, page 9) finds that around 43% of India's disinvestment proceeds between 1991 and 2022 involved no actual transfer to private hands. Shares were transferred between public entities, and the proceeds were counted towards the disinvestment target without any change in underlying ownership. Even where the case for a PSU has lapsed, political incentives corrupt the exit process and sustain enterprises that should not exist.

Applying the framework

Consider three applications of the framework. First, the electricity transmission network exhibits natural-monopoly characteristics, with high fixed costs and declining average costs over the relevant output range. State intervention to address market power is justified ex-ante, whether through regulated private ownership or direct public ownership of the grid operator. Power Grid Corporation of India is a PSU that runs the inter-state grid. From the standpoint of allocative efficiency, tariffs should be set close to marginal cost. Because the marginal cost of transmission is below the long-run average cost, such pricing would generate a structural revenue deficit. A deficit of this kind would not necessarily signal operational inefficiency. It can reflect a deliberate tariff policy that expands access and maximises network use, and it would be justified where it represents the least-cost route to the social objective when compared with direct transfers or alternative subsidy mechanisms. India does not price transmission at marginal cost. Tariffs are set under the CERC Tariff Regulations, 2024, which use a cost-plus framework. For new transmission projects, Regulation 30(3) provides a base return on equity of 15%, along with recovery of interest costs, depreciation, interest on working capital, and operating and maintenance expenses. The PSU's operational record is strong: the transmission system was available 99.85% of the time in FY24 across 1,77,699 circuit kilometres carrying around half of India's inter-state electricity. Whether the cross-subsidy implicit in cost-plus regulation is the least-cost route to network expansion, or whether a direct transfer would deliver the same access at lower fiscal cost, is a question worth asking. Power Grid no longer builds new lines by default. The regulator auctions each new project to the lowest bidder, and Power Grid competes for these contracts alongside Adani, Sterlite and Tata Power. Private bidders win a growing share. Whether the legacy network would also be cheaper in private hands is a separate question. The framework's verdict on Power Grid therefore turns on an empirical question: whether the cost-plus regulation of the legacy network delivers cheaper transmission than competitive procurement would.

Second, the India Tourism Development Corporation (ITDC) runs the Ashok Group of Hotels. ITDC was established in 1966 to develop tourist infrastructure, including hotels. The Taj, Oberoi, ITC, Lemon Tree and Marriott chains, among others, operate across the segments and price points ITDC serves. Hotels are not a public good. Private operators can charge customers, competition is adequate, and there are no externalities, information failure, or market power problems that require the state to own a hotel chain. The market failure test fails at the first step, so no ex-post analysis is needed.

A third example concerns the post-independence wave of public investment in heavy industry and infrastructure. The standard defence of state ownership in this period rested on the absence of capital markets: long-term finance was scarce, and only the state could mobilise it. Bhagwati and Desai (1970) contested this claim, arguing that private capital existed and that the licensing regime was producing the shortages it purported to remedy. Whatever the merits of the original argument, India's capital markets have since deepened. A second defence rests on positive externalities through learning effects and supply-chain spillovers, where social returns exceed what a private investor can appropriate. Underinvestment results from this appropriability gap, even when capital is available. The defence still has limits. Where production subsidies, intellectual property protection, or advance market commitments can close the gap, ownership is the costlier instrument. A surviving PSU founded on these grounds must show that such alternatives remain inadequate.

India's early integrated steel plants at Rourkela, Bhilai, Durgapur, and Bokaro are concrete cases. The plants were justified on grounds that private firms could not raise the long-term capital required, and that they would generate large downstream spillovers through skilled labour, supplier networks, and engineering capabilities whose full social value private investors could not capture. The appropriability gap was real, and thin capital markets compounded the problem by raising the cost of private investment. Both conditions have since changed. India's capital markets have deepened, project finance has matured, and Tata Steel and JSW Steel have built modern integrated capacity at scale. The spillovers that public investment was meant to generate now flow through the private steel industry instead. SAIL, the operator of the original plants, produces around 15% of Indian steel and is profitable. Profitability does not save it from the framework's test. Where private operators produce the same steels at a comparable scale, the market failure has been resolved, and continued public ownership no longer has a justification.

The way forward

Profit is the wrong measure for judging a PSU. It speaks neither to whether the enterprise should exist nor to whether it is doing what it exists to do. For each of India's 291 central PSUs and more than a thousand at the state level, the question is whether a market failure persists, whether ownership is the cheapest way to address it, and whether the enterprise actually does so. Some profitable PSUs would fail this test. Some loss-making ones would pass.

References

India: Planning for Industrialization: Industrialization and Trade Policies Since 1951 by Bhagwati J and Desai P, 1970, Oxford University Press for OECD Development Centre.

On the Management of Public Monopolies Subject to Budgetary Constraints by Boiteux M, 1971, Journal of Economic Theory, 3(3), 219 to 240.

The Lighthouse in Economics by Coase R H, 1974, Journal of Law and Economics, 17(2), 357 to 376.

The Proper Scope of Government: Theory and an Application to Prisons by Hart O, Shleifer A and Vishny R W, 1997, Quarterly Journal of Economics, 112(4), 1127 to 1161.

The Simple Microeconomics of Public-Private Partnerships by Iossa E and Martimort D, 2015, Journal of Public Economic Theory, 17(1), 4 to 48.

In Service of the Republic: The Art and Science of Economic Policy by Kelkar V and Shah A, 2019, Penguin Allen Lane.

The Place of the Soft Budget Constraint Syndrome in Economic Theory by Kornai J, 1998, Journal of Comparative Economics, 26(1), 11 to 17.

A Theory of Incentives in Procurement and Regulation by Laffont J-J and Tirole J, 1993, MIT Press.

Allocative Efficiency vs. "X-Efficiency" by Leibenstein H, 1966, American Economic Review, 56(3), 392 to 415.

State versus Private Ownership by Shleifer A, 1998, Journal of Economic Perspectives, 12(4), 133 to 150.

Arjun Krishnan is a consultant at the Centre for Civil Society, a Delhi-based think tank. He thanks Sourya Banerjee for the early conversations that inspired this article, Jayana Bedi for her thoughtful feedback during its drafting, and an anonymous referee whose comments considerably sharpened the argument.

Markets in everything: using Coasean bargains to resolve culture conflicts

by Samrudha Surana and Bhargavi Zaveri-Shah.

Introduction

In pluralistic societies with multiple, and often conflicting, cultural, religious, or ethical beliefs, disputes between groups with conflicting norms are highly likely. Take the case of a diverse society such as India. Hindus often complain about the Muslim cleric's call to prayer on loudspeakers, non-Hindus complain about the noise levels during celebratory festivals, Jains complain about the eating habits of other communities, and so on. Often, such conflicts get escalated to courts in the form of disputes, to the government in the form of lobbying for bans, or worse, as law and order problems. Pluralistic societies almost always face the following question: how can differences between conflicting norms be reconciled without resorting to State coercion or violence? In this article, we argue that voluntary commercial transactions between parties with conflicting norms are a powerful mechanism to resolve such conflicts.

Drawing from Ronald Coase's work on externalities and property rights, we argue that the principles underlying Coasean bargaining are not limited to economic contexts, but are also broadly applicable to social and cultural disputes. By internalizing the costs associated with conflicting norms, Coasean bargains enable parties to reach mutually beneficial agreements through voluntary exchanges. We illustrate this through a recent real-world example from India, where voluntary market transactions helped members of two religious communities reconcile their conflicting religious norms. A key policy implication of our argument is that it is imperative for policymakers to minimize the transaction costs for such voluntary transactions.

Coasean bargains in theory

Conflicts arise when one person's actions impose costs on another, creating competing interests that must be balanced. The economist, Ronald Coase, illustrated this through an example of cattle owners and farmers (Coase, 1960). Straying cattle may destroy a neighbouring farmer's crops, benefiting the cattle owner but harming the farmer. Preventing the cattle from straying, however, would impose a cost on the cattle owner. The problem is clear: allowing the cattle to stray increases cattle supply at the expense of crops, while restricting their movement favours crops at the expense of cattle. This is a problem of a reciprocal nature. Resolving such conflicts requires determining the value of what is gained versus what is sacrificed. In such cases, using a stream of case law from the US courts, Coase argued that instead of the State determining the hierarchy of who should prevail, one of the parties could internalize the costs arising to the other, from the exercise by the former of her property right. A Coasean bargain offers a way for individuals to resolve such conflicts through voluntary agreements that align their interests and minimize the costs of the conflict. For instance, a farmer might pay a cattle owner to install fencing, or the cattle owner might compensate the farmer for crop damage. When multiple actors are involved-such as several cattle owners and farmers-the feasibility of Coasean bargains depends on the transaction costs. While high transaction costs may prevent agreements in some cases, parties able to negotiate successfully can still improve their situations by reaching mutually beneficial agreements.

While Coase advocated this framework for the allocation of conflicting property rights, in the next few paragraphs, we demonstrate that the framework has implications for enforcing conflicting values as well.

A Coasean bargain in action

Last year, on the occasion of Eid Al Adha (Bakri-Eid) a festival widely celebrated in India and several countries with a significant Muslim population, a group of people were reported to have raised some money and purchased some goats from an Old Delhi market to rescue them from ritualistic slaughter. This incident was seen as an act of religious intolerance on the part of the rescuers. The undertone of these arguments was that the animal rescue on Eid Al Adha was driven by the rescuers' religious intolerance for Muslims and not genuine compassion towards animals. The rescuers profess Jainism, a religion founded on the value of ahimsa (non-violence towards all life forms). The Jain community is perceived to be populated by rich Jain merchants, who generally vote for the BJP. In a society so deeply divided on religion as India is today, this context creates suspicion for the rescuers' motivations behind this act.

The act of rescuing animals through voluntary transactions between the rescuers and the animal vendors is an example of a Coasean bargain that enabled the Jain and Muslim communities to resolve conflicting values without impinging on the rights of the other community. In this incident, the Jain purchasers perceived a harm from the sale of goats for slaughter . But, to stop the sale of goats would have harmed the seller. If the seller refused to sell to the Jains, the cost of slaughtering goats would have been internalized by the seller in the form of forgone payments from the Jains. In this case, the Jains internalized the costs that would have arisen from the slaughter of the goats purchased by them. Both the buyers and the sellers benefitted from the transaction. The sellers of the animals got value for their goats. The buyers got 'value' for their money in the sense that they managed to use the money to honour a value that they hold. As a Muslim man interviewed by the news reporter said in response to this incident, "It's their religion, and if saving animals (like goats) is part of it, we don't mind. Let everyone practise what brings them peace."

Coasean bargains work where the property rights of the people are more or less clearly defined. For example, consider a hypothetical, but realistic, scenario in a diverse urban neighbourhood where a temple's ceremonies or a mosque's call to prayer disturbs the residents of that neighbourhood. Under a Coasean bargaining framework, a standard example similar to this scenario is that of a firm installing a noise-creating windmill affecting the adjoining property owners' enjoyment of their property. In a world where the law confers property rights on people, a negotiation can start. The firm would offer the people some money in exchange for putting up with the noise, and people sensitive to the noise will perhaps use that money to install noise proof windows. These bargains are possible because nuisance has been defined as a tort under common law. That is, the law entitles people to enjoy their property without disturbance. Similarly, in our hypothetical scenario, in a diverse neighbourhood, the group affected by the noise levels might offer to fund the temple's or mosque's acquisition of a quieter sound system to reduce the noise impact. Alternatively, the temple or mosque may make a similar offer to the neighbourhood residents allowing them to enjoy their property without interruption. In the absence of such clarity on property rights, the scope for arriving at Coasean bargains is extremely limited. Similarly, in instances where the property rights are contested, such as whether the land on which a mosque stands belongs to the trust which runs the mosque, Coasean bargains may not offer a solution. In such cases, it would generally fall upon the courts to define the property right.

Coasean bargains versus coercion

A key benefit of Coasean bargains is that they help build a culture of religious tolerance, as compared to the use of State institutions to address religious conflicts. Even in countries whose constitutions allow their citizens the freedom to practice and propagate a religion of their choice, the State machinery is often used to perpetuate religious leanings. For example, in India, almost every year, like clockwork, several petitions are filed at one court or another in or around the festival of Eid-Al-Adha to restrict ritualistic animal slaughter.

Asking the State and courts to resolve these conflicts is problematic as it empowers them to impose a hierarchy of values on the society at large. For example, in the case illustrated above, a court order restricting the rights of Muslims to slaughter animals would have impliedly placed a higher value on the ritualistic notion of slaughter than the Jains' religious notion of non-violence towards animals. Since courts are designed to enforce rights and interpret laws, they are ill-suited to resolve conflicting values or norms that do not contradict the law. For example, consider the following conflicting values:

1. animal welfare activists rescuing goats from ritualistic slaughter
2. climate activists purchasing ceramic Ganesha idols from the vendors of such idols and disposing them to pre-empt them from being submerged in the ocean
3. climate activists purchasing firecrackers during Diwali and disposing of them to pre-empt noise and air pollution

It is hard for any central institution to explain why one of these values should take precedence over the other, and then impose such preference ordering over the rest of society. In a voluntary transaction, on the other hand, the question of addressing the hierarchy of values is immaterial, since the transaction is based on the subjective value that each party places on their beliefs. A Coasean bargain allows the people practising these conflicting values to order their preferences without forcing them to do so. Further, empowering the State creates opportunities for rent seeking. In electoral democracies, this risks allowing a majoritarian bias to be played out in such conflict resolution, and exacerbates the mistrust of people in the State and the courts.

Voluntary transactions that allow the transacting parties to uphold norms that are important to them are similarly preferable to the common counterfactual of violence, aggression and the exclusion of practices that don't meet one's religious or philosophical leanings.

Conclusion

The Coasean framework underscores the power of voluntary agreements to internalize costs and balance competing economic interests between persons. We extend this intuition to the resolution of conflicting religious and cultural norms, which are likely to exist in any pluralistic society. The incident of Jain members purchasing goats during Eid Al Adha demonstrates how Coasean bargaining through market mechanisms can resolve religious conflicts without state intervention. This case demonstrates that voluntary market transactions, motivated by individual preferences, can yield broader societal benefits by reducing friction between conflicting norms. In a country like India that is ridden with cow protection laws, state sponsored beef bans and religious violence, the volition of this transaction has tremendous significance.

While rooted in a specific cultural context, the insights derived from this example resonate beyond India. The Coasean approach underscores how the market enables each party to achieve their goals while respecting others' freedoms, creating positive societal benefits as an unintended consequence. Many seemingly intractable conflicts between religious communities might find resolution not through legal battles or state intervention, but through Coasean bargaining, where mutual respect and cooperation emerge naturally from the market process, even when religious tolerance itself is not the participants' primary goal.

Finally, as Coase emphasized, the feasibility of these transactions is dependent on the transaction costs. In environments with high transaction costs, such transactions will be fewer, if at all. The goal of the policymaker, therefore, should be to lower the transaction costs to make Coasean bargains between extremely unlikely transacting parties work.

Reference

Coase, Ronald (1960), "The Problem of Social Cost", Journal of Law and Economics, 3 (Oct., 1960).

The authors thank Ajay Shah and three anonymous referees for their inputs.

Digital transformation and the paradox of financial inclusion in India

by Suyash Rai.

India has made great strides in digital technology, becoming a leading exporter of digitally delivered services to the global economy. These capabilities with computer technology fuelled hopes that digital transformation could yield gains for the Indian state that are comparable to those seen in the private sector. The `Digital Public Infrastructure (DPI)' approach, with India's Aadhaar digital ID system as a prime example, is presented as a path to higher GDP growth for developing countries. There is an emerging debate on the role of the state in shaping the development and deployment of DPIs.

Two key pillars of the Indian story with DPIs are identity services ("Aadhaar") and their impact on financial inclusion. In a new working paper, Economic development and digital transformation: Learning from the experience of Aadhaar and financial inclusion in India, I critically examine the Indian progress on financial inclusion between 2011 and 2021, revealing a paradox: while account ownership surged, account usage remained low.

The facts

The paper analyses India's performance compared to other lower middle-income and middle-income countries. The evidence shows:

• Impressive account opening: India witnessed remarkable progress in account penetration, surpassing the average improvement in middle-income countries.
• High inactivity: A significant percentage of accounts in India were inactive, far exceeding the average for middle-income countries.
• Low account usage: India lagged behind in account usage for both consumption smoothing (regular deposits and withdrawals) and digital payments, indicating a gap between account ownership and actual financial inclusion.

The role of government mandates and Aadhaar

We argue that the rapid scale of account opening was caused by a series of government and Reserve Bank of India (RBI)mandates, particularly the Pradhan Mantri Jan Dhan Yojana (PMJDY). While Aadhaar played a role, it was primarily used as a physical ID for KYC, rather than as a digital ID through e-KYC. The gains in account opening may have a lot to do with state coercion and less to do with DPI.

The primary objective driving these initiatives was to facilitate direct benefit transfers (DBT) for welfare schemes. The government's focus on DBT aimed to reduce leakages and improve attribution for its welfare programs in the eyes of voters.

Why did this approach yield disappointing results?

The paper explores several reasons for the limited account usage despite the increase in account ownership:

• The lack of a viable business model: No-frills accounts, with zero minimum balance and free transactions, are commercially unattractive for banks.
• Mismatch between the solution and the problem: The focus on account opening for DBT didn't necessarily translate into accounts that address the richness and complexity of finance for the poor, of meeting the diverse needs of users for consumption smoothing and payments.

Lessons

The top-down approach, with a readiness to utilise the coercive power of the state, has limitations. While the government achieved its objective of scaling up DBT, this came at the cost of genuine financial inclusion and limited the potential uses of Aadhaar as a DPI.

We highlight the need for a more balanced approach, considering market forces and user needs, so as to obtain better outcomes with DPIs. We stress the importance of political creativity, institutional reforms, and a broader understanding of public value, beyond narrow fiscal objectives, when designing and implementing DPIs.

We offers insights into the complexities of digital transformation and financial inclusion, challenging the simplistic narrative of Aadhaar's success. These experiences invite us to rethink the role of the state in shaping DPIs and consider alternative approaches that can truly leverage technology for inclusive and sustainable development.

Suyash Rai is a Fellow at Carnegie India and a Visiting Research Fellow at the xKDR Forum

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Reducing challenges to arbitration awards: lessons from court data

by Madhav Goel, Akshay Jaitly, Renuka Sane and Anjali Sharma.

Contracts form the bedrock of economic activity in the formal economy. As an economy grows, so does its reliance on contracts. Delays and friction in contract enforcement erode trust in contracts and inhibit the pace of economic growth. In India, contract enforcement generally falls in the jurisdiction of the civil court system, which, according to the National Judicial Data Grid, has more than 11 million pending cases and takes, on an average, more than three years to dispose of a case. One of the solutions to an increasingly overburdened court system in India has been to move certain types of matters to a different judicial forum, either a specialised court or tribunal or by using an alternate dispute resolution (ADR) mechanism. Arbitration is one such alternative mechanism, the framework for which is provided by the Arbitration and Conciliation Act, 1996 (A and C Act).

Contract enforcement by private persons against the state in India brings its own set of problems. Increasingly, government contracts provide for dispute resolution by arbitration. However, anecdotal evidence suggests that the state consistently challenges adverse arbitration awards. In this article, we use Delhi High Court data on challenges to arbitration awards for matters in which the National Highways Authority of India (NHAI) was a party. We analyse the grounds on which these awards were challenged and the manner in which the court dealt with these challenges.

Our main finding is that both the NHAI and the private parties challenge adverse arbitration awards, most often on the merits, even though the A and C Act specifically prohibits this. We also find that the court generally does not interfere with arbitral awards, which is in line with the legislative intent. However, this does not deter such challenges. This may be for a variety of reasons, such as the relatively low cost of litigation vis-a-vis the award value or the incentives of decision makers within the state.

Our analysis adds to the intersection of two growing bodies of recent work in India on the subject. The first that studies government contracting, both from a public administration lens and from the lens of how the government impacts ease of doing business and business outcomes (Chitgupi and Thomas (2023), Burman and Manivannan (2022), Mehta and Thomas (2022), Manivannan and Zaveri (2021), Shah (2021), Roy and Sharma (2020)). The second studies the functioning of courts and the manner in which they deal with a variety of matters (Manivannan et. al. (2021), Damle et. al. (2021), Sharma and Zaveri (2020), Gulati and Sane (2021), Bhatia et. al. (2019)).

The organisation of this article is as follows. We first provide an overview of the legislative and judicial framework to challenge an arbitral award, i.e., Sections 34 and 37 of the A and C Act. We then describe our data set and our methodology for analysis. This is followed by our findings and some recommendations on the way forward.

An overview of Sections 34 and 37 of the A and C Act

The design of the A and C Act allows for a two-stage sequential challenge to outcomes of arbitration proceedings, first under Section 34 and then under Section 37 of the Act. Section 34 provides 5 procedural and jurisdictional grounds, along with 3 additional grounds to set aside an arbitral award. These are:

• Procedural and Jurisdiction:
• The party was under some incapacity while entering into the arbitration agreement;
• The arbitration agreement was not valid under the law to which the parties have subjected it;
• The party making the application was not given proper notice of appointment of arbitrator or of arbitral proceedings, or was otherwise unable to present its case;
• The arbitral award dealt with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or it contained decisions on matters beyond the scope of the submission to arbitration; or
• The composition of the arbitral tribunal or the arbitral procedure was not in accordance with the agreement of the parties or the A and C Act, as the case may be.
• Additional Grounds:
• The subject matter of the dispute was not capable of settlement by arbitration;
• The award is in conflict with the public policy of India, i.e., award is affected by fraud or corruption, or is against the fundamental policy of Indian law, or is in conflict with the most basic notions of morality or justice; or
• The award is vitiated by patent illegality appearing on the face of the award.

It is useful to note that Section 34 proceedings are not appeals (Delhi Airport Metro Express (P) Ltd. v. DMRC (2022)), and the grounds for challenge are limited by the A and C Act itself (Union of India v. Annavaram Concrete Pvt. Ltd. (2021)). Under the scheme of Section 34, an arbitral award cannot be set aside on merits, that is, on the grounds of erroneous application of law or by re-appreciation of evidence (MMTC Limited v. Vendanta Limited (2019); PSA SICAL Terminals (P) Ltd. v. Board of Trustees of V.O. Chidambranar Port Trust Tuticorin (2021)). Therefore, unless an arbitral award is set aside under the grounds laid down in Section 34, it is ready for execution as a civil court decree against the award debtor. Section 37 of the A and C Act, on the other hand, is an avenue of appeal against an order under Section 34 of the Act. Accordingly, proceedings under Section 37 are governed by the Code of Civil Procedure, 1908 (CPC) and are in the form of an appeal. However, through consistent judicial pronouncements, the grounds for appeal under Section 37 have been restricted, even as compared to the grounds under Section 34 (Mahanagar Telephone Nigam Limited vs. Applied Electronics Ltd. (2014)).

While the A and C Act is, to a large extent, modeled on the UNCITRAL Model Law on International Commercial Arbitration, 1985, it deviates from the Model Law in two important ways. First, it introduces an additional ground to challenge an arbitral award: patent illegality appearing on the face of the award. Second, it provides for a two-stage appeal process, where Section 37(1)(c) of the Act allows an appeal against an order under Section 34 setting aside or refusing to set aside the arbitral award. These two deviations from the Model Law have implications for the efficacy of the arbitration framework in India. The ground of patent illegality introduces ambiguity and discretion in the otherwise procedural nature of the process of challenging awards. The two-stage appeal process adds to this ambiguity and discretion, and introduces delays in the enforcement of the award. Section 36 of the A and C Act, under which an award is enforced as a decree, adds to these challenges. Section 36(2) specifically gives the court the power to stay the enforceability of an award. Section 36(3) specifies the conditions under which the court may grant such a stay.

Data and methodology

For our analysis, we collected judgments from Delhi High Court for the years 2018 and 2019 pertaining to matters where the NHAI is a party. Our choice of Delhi High Court is due to its importance as a court for arbitration matters, as well as because NHAI matters are likely to be brought before it.

Our choice of the years 2018 and 2019 is driven by three factors. First, the arbitration framework has undergone significant legislative change since 2015 and more recent data reflects the current framework. Second, the period from 2020-2022 was marked by disruptions in the judicial system due to the COVID-19 pandemic, and therefore, may not represent the ordinary course of dispute resolution. Finally, the choice of 2018 and 2019 allows for the possibility of extending our analysis to studying the entire life-cycle of such litigation all the way to the Supreme Court.

We focus on the NHAI because of its status as an autonomous, specialised statutory body that has been tasked with development, maintenance and management of India's national highways. NHAI is also one of the largest contracting bodies within government, accounting for nearly 10 percent of the total union government expenditure on public procurement (Sharma and Thomas (2021), Chitgupi, Gorsi and Thomas, (2022)).

We find 96 judgments in Delhi High Court where NHAI is a party. Of these, 82 pertain to matters under Sections 34 and 37 of the A and C Act (details can be found by clicking here) From these 82 judgments, we collect the following details:

1. The nature and quantum of claims filed before the arbitral tribunal;
2. The party that won the arbitration;
3. The time taken between filing the petition under Section 34 or 37 of the A and C Act to the final judgment;
4. The nature of disputes and grounds for the petition under Section 34 or 37; and
5. Which party won, and the quantification of the claims that were upheld/set aside by the Court.

Findings

Our main finding is in regards to the win-loss record for a challenge to an arbitral award under Sections 34 and 37 of the A and C Act, i.e., the likelihood of success in challenging the arbitral award (Table 1).

Table 1: Outcome of Section 34 and 37 Challenges

Categories	2018	2019	Total
Petitioner won	4	4	8
Petitoner lost	44	30	74
Total	48	34	82
Source: Delhi High Court judgments

We find that in 74 of the 82 cases (90.2%) involving NHAI, the court refused to interfere with the arbitral award, irrespective of whether the party challenging the award was the NHAI or the private party. This suggests two things. First, the Delhi High Court's action of ordinarily not setting aside the arbitral award is in line with the legislative intent of Sections 34 and 37 of the A and C Act. Second, despite the court not interfering with the award, parties continue to mount such challenges. This is especially so for NHAI, which is the petitioner in 67 out of the 82 matters.

When we look at the grounds under which awards are being challenged in court (Table 2), we observe that the bulk of the challenges, 77 out of 82 (93.9%), are under Section 34(2A), which is unlike the provisions of the UNCITRAL Model Law, and is an Indian innovation that allows the award to be reviewed on the basis of the substantive merits of the case. Patent illegality is a subjective formulation whose treatment may change from case to case and from court to court.

Table 2: Nature of Section 34 challenges

Provision	2018	2019	Total
S. 34(1)	2	1	3
S. 34(2)	-	-	-
S. 34(2A)	45	32	77
S. 34(3)	1	1	2
Source: Delhi High Court judgments

The findings from Tables 1 and 2 together indicate that award debtors routinely challenge arbitral awards on substantive merits, even though the courts routinely turn down such challenges.

We also find that, on average, it takes the court 805 days (2.2 years) to dispose of a Section 34 challenge and 208 days (0.6 years) to dispose of a Section 37 challenge. A matter in which both Section 34 and 37 challenges are brought will be in court for about 3 years after the award has been made by the arbitral tribunal.

In 36 of the 82 matters, we get data for the size of the claim. The total value of claims, across these 36 cases, is Rs. 17.5 billion and the average per case claim value is Rs. 485 million. While these may not be significant for an entity of NHAI's scale, for private parties dealing with NHAI, these may be consequential. And so may be the additional time of three years and the cost of litigation to secure these claims.

Some simple calculations also give us a sense of what these challenges with minimal chance of success mean for the government. At an interest rate of 8% per annum (MCLR during 2018 and 2019 was in this range), compounded annually, after the three year litigation challenging the arbitral award, the government will have to bear an additional interest cost of Rs. 4.5 billion on these awards. This does not take into account the cost and time consumed by the litigation.

Why do parties challenge arbitral awards?

There may be two main reasons why parties continue to appeal even though the chances of the award being overturned are low:

• Low costs: for large value awards, the cost of the litigation challenging the arbitral award is lower than the expected benefit to the award debtor even at low probability of the award being overturned (Mehta and Thomas (2022) supra). Additionally, for the government, the economic considerations around litigation costs may not be as relevant as for private litigants. Empanelled lawyers for the government and its agencies are often remunerated far less than lawyers representing private parties. Further, incentives of the bureaucracy are often such that they do not accept adverse outcomes in contractual disputes and litigate till the last available forum, regardless of cost.

• Delaying the enforcement: parties may resort to challenging the award to delay enforcement. Filing a petition under Section 34 of the A and C Act often forces the award holder to delay an execution petition under Section 36 of the Act. This could be because of the uncertainty regarding the outcome of the challenge, and due to potentially wasteful litigation costs, should the award be stayed or overturned. Anecdotal evidence shows that the executing court is often cognizant of the filing of a petition under Section 34 while taking substantive decisions under Section 36 of the Act. The executing court typically awaits the outcome of proceedings under Section 34 or 37 before taking any coercive action against the award debtor. Therefore, it is likely that much of the litigation under Sections 34 and 37 is a means of delaying enforcement of the award, and not because the litigants expect to succeed.

Legislative solutions

Disincentivising litigants from challenging arbitral awards on merits, especially if the litigant is the government, is important to ensure that the A and C Act remains relevant as an alternate dispute resolution mechanism. This can be achieved through two levers. First, that courts take up Section 34 challenges only in cases where there is a high likelihood of the challenge succeeding. Second, the cost of challenging the award either under Section 34 or Section 37 are high enough to alter the economic incentives of the award debtor. To this effect, we suggest three legislative solutions:

1. Amending Sections 34 and 37 of the A and C Act to introduce a prima facie test of satisfaction: As the law stands currently, the courts must hear petitions under Sections 34 or Section 37 and decide them on merits, irrespective of the grounds of challenge and the chances of success. This takes up significant resources. Introducing a prima facie test of satisfaction will enable the Court to dismiss the petition at the pre-notice stage itself, unless the petitioner is able to satisfy the court that it has a good case on merits. This will be similar to the procedure adopted by the Supreme Court while hearing fresh special leave petitions under Article 136 of the Constitution of India. The decision of the court to entertain a petition under Section 34 or Section 37, based on a prima facie view of the merits, has cost advantages to the litigants as well as the court. Dismissal at the pre-notice stage means that the litigants do not bear the cost of a full appeal and the court also spends less time and resources in deciding the petition on merits (Shavell (2010)). Further, deciding the merits at the pre-notice stage may also reduce time and costs during the full appeal as part of the assessment of the merit will already have been done by the court.

2. Amending of Sections 34 and 37 of the A and C Act to introduce a mandatory pre-deposit of fees proportionate to the arbitral award for the admission of petitions to set aside arbitral awards: As pointed out earlier, the economic incentives are stacked in favour of a challenge to the award. One way of counteracting this would be to increase the cost of a challenge. This can be achieved by adopting a mandatory pre-deposit of a proportion of the award value with the court before a challenge can be instituted. Such a pre-deposits can be tiered, with a higher proportion being required under Section 37 as compared to Section 34.

Another way of achieving this outcome will be to amend Section 82 of the Act to introduce a clarification that empowers the courts to frame rules to introduce barriers to unmeritorious challenges. These could include, as suggested above, a prima facie test or a mandatory pre-deposit of a proportion of the award value under challenge. This method leaves the discretion of framing such rules, and the substance of these rules with each High Court which could take into account local conditions while framing them. Further, the desired objective will be achieved without hard coding too much detail in the statute itself, which might make it inflexible and require more amendments going forward.

In October, 2021, the General Financial Rules, 2017 (GFR), the procurement rules for union government and its agencies, were amended to introduce Rule 227A which requires government departments challenging arbitral awards to pay 75% of the award value into an escrow account, to be used sequentially for the settlement of lender's dues, project completion and then as payment to the contractor. However, the impact of this change is in respect of of government challenges to arbitral awards. Our analysis shows that even private parties routinely challenge arbitral awards, and hence an amendment to the A and C Act introducing a pre-deposit may be desirable.

3. Amending Section 37(1)(c) to remove the second challenge avenue for the award debtor: Section 37(1)(c) of the A and C Act permits an appeal of the order of the court either setting aside or refusing to set aside an arbitral award under Section 34. This affords the award debtor a second avenue to continue litigation and stave off enforcement of the award. Our analysis shows that while courts generally uphold the award even during this challenge, both time and resources of the court and the litigants are consumed. Further, even at this stage courts may adjudicate the matter on merits, despite this already having been done at the award stage and at the Section 34 stage. Further, as mentioned earlier, no analogous provision to Section 37(1)(c) exists even in the Model Law as well as the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

   One possibility is to completely remove Section 37(1)(c) from the A and C Act and align the framework for challenging an arbitral award with the Model Law. Alternatively, Section 37(1)(c) could be amended to remove the appeal available to the award debtor, but retain the appeal available to the award holder. This will protect against frivolous appeals by the award debtor, while providing adequate remedy in matters where an award has been erroneously overturned under Section 34.

Conclusion

In India, delays of the court system have increasingly led both government and private parties to opt for ADR mechanisms such as arbitration to resolve contractual disputes. However, for arbitration to be used effectively, it is important that challenges to the outcome of arbitration are limited to the procedural and jurisdictional grounds laid down in the A and C Act. Our analysis shows that this may not be so, and that both government and private parties routinely challenge arbitral awards on merits. Challenges to arbitration awards appear to have become a way of delaying enforcement. The Delhi High Court has been sanguine in the manner of its dealing with these challenges, most often refusing to interfere with the arbitration outcome. However, this does not seem to have deterred challenges, especially from government agencies.

One way of disincentivising such challenges is to amend the A and C Act to remove the legislative loopholes. These include: (i) introducing a prima facie test of the merits of the challenge, (ii) seeking a pre-deposit of a part of the award value before allowing a challenge, and (iii) removing the second challenge permitted under the Act. These changes could go a long way in curbing the litigious behaviour of parties to delay enforcement of high value awards.

Contract enforcement is hard when there exists an imbalance of power and resources between the parties to a contract or where the incentives of one of the parties are not driven entirely by commercial considerations, as in the case of government contracting with private parties. Creating legislative boundaries against strategic actions by parties, whether government or private, is one way of dealing with this challenge. There are other ways, that seek to change the behaviour of government departments and agencies, through measures such as a National Litigation Policy or the government procurement rules.

References

Aneesha Chitgupi and Susan Thomas, Learning by doing for public procurement, XKDR Working Paper No. 22 (2023).

Pavithra Manivannan, Susan Thomas, and Bhargavi Zaveri-Shah, Helping litigants make informed choices in resolving debt disputes, The Leap Blog (2023).

Anirudh Burman and Pavithra Manivannan, Delays in government contracting: A tale of two metros, The Leap Blog (2022).

Aneesha Chitgupi, Abhishek Gorsi, and Susan Thomas, Learning by doing and public procurement in India, The Leap Blog (2022).

Charmi Mehta and Susan Thomas, Identifying roadblocks in highway contracting: lessons from NHAI litigation, The Leap Blog (2022).

Pavithra Manivannan and Bhargavi Zaveri, How large is the payment delays problem in Indian public procurement?, The Leap Blog (2021).

Ajay Shah, The bottleneck of government contracting, Business Standard (2021).

Anjali Sharma and Susan Thomas, The footprint of union government procurement in India, XKDR Working Paper No. 10 (2021).

Devendra Damle, Karan Gulati, Anjali Sharma, and Bhargavi Zaveri-Shah, Litigation in public contracts: some estimates from court data, The Leap Blog (2021).

Karan Gulati and Renuka Sane, Grievance Redress by Courts in Consumer Finance Disputes, The Leap Blog (2021).

Anjali Sharma and Bhargavi Zaveri, Judicial triage in the lockdown: evidence from India's largest commercial tribunal, The Leap Blog (2020).

Shubho Roy and Anjali Sharma, What ails public procurement: an analysis of tender modifications in the pre-award process, The Leap Blog (2020).

Surbhi Bhatia, Manish Singh, and Bhargavi Zaveri, Time to resolve insolvencies in India, The Leap Blog (2019).

Steven M. Shavell, On the Design of the Appeals Process: The Optimal Use of Discretionary Review versus Direct Appeal, 39 J. Legal Stud. 63 (2010).

Delhi Airport Metro Express (P) Ltd. v. DMRC, (2022) 1 SCC 131.

Union of India v. Annavaram Concrete Pvt. Ltd., (2021) SCC OnLine Del 4211.

MMTC Limited v. Vendanta Limited, (2019) 4 SCC 163.

PSA SICAL Terminals (P) Ltd. v. Board of Trustees of V.O. Chidambranar Port Trust Tuticorin, (2021) SCC OnLine SC 508.

Mahanagar Telephone Nigam Limited vs. Applied Electronics Ltd., AIR (2014) Delhi 182.

Madhav Goel, Renuka Sane and Anjali Sharma are with the TrustBridge Rule of Law Foundation. Akshay Jaitly is the co-founder of TrustBridge Rule of Foundation and Partner, Trilegal. We thank Karan Gulati, Ajay Shah and two anonymous referees for their inputs and comments.

Who is litigating cheque bounce cases?

by Siddarth Raman.

Cheque bounce cases under Section 138 of the Negotiable Instruments Act are an important source of case load at the Indian judiciary. This has inspired many attempts at modifying laws and court procedures so as to reduce the burden. In this journey, empirical evidence about the nature of the litigants is required. In this article, we establish a dataset about these matters, and measure the shares of financial firms, non-financial firms and individuals. We find that in Mumbai, financial firms filed 52% of cases, and that 83% of cases were against individuals. Cases filed by financial firms are likely to be disposed quicker than those filed by individuals. We explore how the cheque is used as a means of credit, and why financial firms accept them as collateral / security. It appears that financial firms are using cheques and Section 138 as a coping mechanism for poor civil remedies. While there is a need for legal system reform in the context of S.138 of the N.I. Act, it would also be useful to find solutions in banking regulation and personal bankruptcy law. We conclude with a recommendation of caution. Just as the amendment in 1988 has led to certain behaviours and industry practices, new solutions will alter the equilibrium, creating new incentives and new behaviours. The patterns seen in Mumbai are not present in regions of lower economic activity like Jhabua-Nimar. We need to be aware of the wide differences across different districts and states of India, and be mindful of complexity, as we proceed on the path to legal system reform.

Introduction

Section 138 of the Negotiable Instruments Act, which was introduced in 1988, creates the possibility of imprisonment for upto two years, a fine upto twice the amount of the cheque, or both, in response to cheque bouncing. The Act prescribes a six month time horizon for disposing these cases. This 1988 amendment is widely used as an example of the need for judicial impact assessment: The legislative action substantially enhanced the load upon the judicial branch, but there was a lack of commensurate operational planning and resourcing to deal with the enhanced case load.

What fraction of the pending cases or the flow of new cases emanates from this? A precise answer to this is not feasible under the present state of legal system data in India, but it is likely to be about 15 per cent (Chapter 3, Law Commission of India, 2014 ^[1] ; Supreme Court in Makwana Mangaldas Tulsidas vs The State Of Gujarat, 2018 ^[2] ; Mahadik D, 2018 ^[3] ). An important paper in this literature, Damle and Gulati, 2022 ^[4] examines 363,720 cases across 8 States and 2 Union Territories and estimates that cheque dishonour cases represent 13.2% of the courts' workload and take 395 days for disposal.

One pathway to legal system reform lies in an 80:20 analysis, in a vertical approach of finding solutions that are specific to certain classes of matters. Many thinkers have proposed making progress on S.138 of the N.I. Act as a component of legal system reform (Law Commission of India, 2008 ^[5] ; Law Commission of India, 2009 ^[6] ). Alongside this is the proposal for decriminalisation of cheque bouncing, broadly drawing on the concept that debtors prisons are not how modern economies operate. All these discussions require more knowledge about the nature of litigants in these matters, which is presently lacking.

This article seeks to fill this gap. In their paper, Damle and Gulati, 2022 ^[4] establish that the impact of Section 138 cases on caseload, pendency and time to disposal varies by State. We ask the questions: Who are the litigants in Section 138 cases? Does the nature of cases vary based on who the participants are? Do these characteristics vary based on location?

Methodology

The e-courts database for district courts was used to build a dataset about pending and disposed cases relating to Section 138 of the Negotiable Instruments Act. This was done for India's most advanced region (Bombay). For a comparison, this was also done for the group of districts (termed "homogeneous region" by CMIE) with the highest share of households in agriculture. This is the "Jhabua-Nimar" homogeneous region, which comprises six districts in Madhya Pradesh - Alirajpur, Barwani, Burhanpur, Dhar, East Nimar (Khandwa), Jhabua, West Nimar (Khargone). These two datasets thus show the full range from the old India to the new India.

Litigants were classified into three groups:

• Financial Firms
• Non-Financial Firms
• Individuals

This was done through a process of looking for keywords in the name:

1. Financial Firms typically have the terms bank, finance, invest, loan, and related keywords and variations.
2. Non Financial Firms have terms like ltd, pvt, corporation.
3. Non Financial Firms may contain common nouns from the English Language.
4. Litigants with the term proprietor in the name were categorised as individuals.
5. Those that did not fit these criteria were categorised as individuals.

This classification heuristic requires a standard corpus of English words. We used the NLTK Wordnet corpus and identified all words in the names of litigants that overlapped. A manual cleanup was required as the corpus contained some proper nouns. We assessed the words which made up 95% of the instances of overlap with the corpus and eliminated names and common nouns that could be Indian names ("Rout", "Harsh", "Baby", etc.). In Mumbai, we found 8133 unique words appearing 763,593 times. The 95% filter resulted in 1,165 unique words in Mumbai. For Jhabua-Nimar, we found 1,006 unique words appearing 19,974 times. The 95% filter resulted in 345 unique words.

These heuristics will of course engage in a small rate of misclassification. Some names like Banku and Chitra containing the terms Bank and Chit could be classified incorrectly. We do not account for firms that have common nouns in their name from languages other than English. In many cases, an individual proprietorship may have the term company or finance in their name. The methodology does not take into account spelling errors.

In order to assess the accuracy of the work, it is important to estimate the defect rates associated with these heuristics. We manually analysed a random sample of 100 cases (and 200 litigants) in each district, in order to measure the error rate. We found two errors in our Mumbai analysis. They are:

1. Ms M. D. Vora Co. is a non-financial firm categorized as an individual.
2. Alexander Xavier Dsouza is an individual categorized as a non-financial firm. Alexander is present in the wordnet corpus, and appears 16 time in the dataset which puts it in the bottom 3% of words by frequency, which is why it was excluded in the manual cleanup.

Similarly, we found seven errors in our Jhabua-Nimar analysis. They are:

    Two cases where non-financial firms with names in Hindi were misclassified as individuals:

1. Shri Krishna Prajapati Sakh Sahkari Sanstha Maryadit.
2. Shubhalakshmi Sakh Sahkari Sastha Mrya. Dhamnod By Nitesh Bhawsar.

    Two cases where financial firms with typos were misclassified as individuals:

3. EEASVAM KREDIT KO DVARA VIJAY.
4. BHARATEEY STET BAIANK MUKHY SHANABAG BURAHANAPUR.

    One case of an individual misclassified as a financial firm:

5. Kashish Finance H.U.F Propriter Vijay Rathore.

    Two cases where the State was a party. The State was misclassified as a non-financial firm.

This suggests a defect rate of 1% for Mumbai and 3.5% for Jhabua-Nimar. This gives us a sense of the extent to which the estimates presented ahead should be treated with caution.

Results

In Mumbai, we have a dataset of 417,437 cases. Of these, 317,225 are disposed, and 99,712 cases are pending.

Table 1: Section 138, NI Act cases in Mumbai district courts classified by Type of Litigant

Respondents → Petitioners ↓	Financial firm	Non-financial firm	Individual	Total
Financial firm	0.2%	6.5%	46.2%	52.8%
Non-financial firm	0.1%	7.0%	21.3%	28.4%
Individual	0.2%	4.8%	13.8%	18.8%
Grand Total	0.5%	18.3%	81.2%	100.0%

This yields the facts:

• Finance firms filed 53% of cases, non-financial firms 28%, and individuals 19%.
• 81% of cases were filed against individuals, 18% against non-financial firms and less than 0.5% against financial firms.
• The biggest chunk of cases are financial firms vs individuals - 46%, followed by non-financial vs individuals - 21%.

In Jhabua-Nimar, we have a dataset of 22,564 cases. Of these, 14,130 are disposed, and 8,434 cases are pending.

Table 2: Section 138, NI Act cases in Jhabua-Nimar district courts classified by Type of Litigant

Respondents → Petitioners ↓	Financial firm	Non-financial firm	Individual	Total
Financial firm	0.0%	0.2%	12.3%	12.5%
Non-financial firm	0.0%	0.6%	5.2%	5.8%
Individual	0.1%	2.1%	79.5%	81.2%
Grand Total	0.1%	2.9%	97.0%	100.0%

• Individuals filed 82% of cases, finance firms 12%, and non-financial firms 6%.
• 97% of cases were filed against individuals, 3% against non-financial firms.
• The biggest chunk of cases are individuals vs individuals - 80%, followed by finance firms vs individuals - 12%.

At an overall level, disposal rates in Mumbai are close to 90%+ for years before 2015, from where we see a steady decline in share of cases disposed. Thus today's pending cases are largely those that began after 2015.

Figure 1: Total Cases by Year and % of Cases disposed as of April 2023

In Figure 1 above, the blue bars on the chart are the total number of cases filed. The orange line depicts the % of the cases filed in that year which stand disposed as of April 2023 when the data was analysed.

In Mumbai, we see an interesting pattern when we compare the disposal rates of cases filed by financial firms, non-financial firms and cases filed by individuals.

Table 3: Share of cases filed in a specific year that stand disposed as of 2023

Year	Financial Firms	Non-Financial Firms	Individuals
2015	74.0%	65.9%	66.9%
2016	61.1%	60.7%	66.4%
2017	77.8%	50.8%	51.1%
2018	75.9%	47.9%	41.1%
2019	48.8%	42.8%	28.9%
2020	75.3%	35.0%	27.6%
2021	42.2%	25.5%	19.6%

This table shows the share of cases that were filed in Mumbai in a certain year that are now disposed. An important finding here is that cases filed by financial firms have a much higher likelihood of getting disposed in 2-3 years compared with cases filed by individuals.

Figure 2: Cases filed between 2015-2021 by Status and Type of Litigant

In Figure 2 above, we see that Financial Firms account for 60% of the total cases filed, but constitute ~70% of the cases that have been disposed, and account for only 50% of the pending cases.

We see no such patterns in Jhabua-Nimar with disposal rates not being dependent on the nature litigant filing the case.

Discussion

We now have new facts about litigation associated with the S.138 of the NI Act. What have we learned? How does this change our mind? What are the downstream implications of this new knowledge?

Most attempts at reforming Section 138 have focused on on improving the processing speed within courts. Little has been done towards preventing cases emerging in the first place. Our data shows that financial firms are the main petitioners in Mumbai, with a higher disposal rate than individual litigants or non-financial firms. This may reflect greater organisational capability in financial firms. Cases filed by individuals or non-financial firms vary based on the nature of contract entered into by the two parties. We speculate that cases filed by financial firms are mostly related to loans.

Financial firms often use cheques as an alternative form of collateral. This can help individuals with poor credit ratings to access loans. Should there be a loan default, there is the choice of filing a criminal case. This process is expedited by Section 138 that requires petitioners to file a case within 45 days of the cheque bounce. Banking regulations may also be a contributor. In December 2016, the Supreme Court ruled that officers of private banks are to be treated as public servants under the Prevention of Corruption Act. Financial firms have practices to ensure that a debt is indeed irrecoverable before they can classify it as bad debt. The large volume of cases from banks may be a mechanism to check against petty corruption from branch officials and comply with regulatory requirements.

Filing a Section 138, NI Act case not only allows a bank official to demonstrate effort and intent, it also allows the lender access to the coercive power of the State. The police arriving with a non-bailable warrant at your doorstep is a persuasive means of negotiating with a borrower. Petitioners in a Section 138 case are using this to recover dues. Are there better civil alternatives to debt recovery? How does their efficiency in terms of time to disposal compare with those in Section 138 cases? As we think of improving processes, we should consider the possibility that making Section 138 cases more efficient may prevent litigants from considering civil recourse. The combination of slow civil courts and under-developed credit markets make Section 138 cases an attractive proposition for financial firms. Accepting cheques as security may have developed as an industry practice because it allows financial firms to be less diligent when making loans as they can now rely on the criminal justice system to coerce settlement. In addition to court processes and legislative changes, remedies to the burden of Section 138 on the Indian courts may also lie in the realm of banking regulation, credit practices, and personal bankruptcy law.

The introduction of Section 138 has resulted in some discernable behaviors from financial firms. Future changes to the status quo will invariably alter incentives resulting in different behavioral patterns among litigants. The variation in litigant composition between different regions illustrates that litigation patterns are shaped by local context. The patterns observed in a metro like Mumbai, largely influenced by financial firms, don't find a parallel in areas such as Jhabua-Nimar. Attempts at legal system reform must account for the disparities across the various states and districts of India. We caution against one-size-fits-all solutions and suggest that solutions be crafted keeping in mind the local context.

References

[1] 245th Report On Arrears And Backlog - Law Commission of India, 2014 . Retrieved from 20th Law Commission of India.

[2] Makwana Mangaldas Tulsidas vs The State Of Gujarat , Order dated 5 March, 2020. Retrieved from Supreme Court of India.

[3] Mahadik D, 2018. Analyses of Causes for Pendency in High Courts and Subordinate Courts in Maharashtra. Retrieved from Department of Justice.

[4] Damle D, Gulati K et al. 2022. Characterizing Cheque Dishonor Cases in India: Causes for Delays and Policy Implications. SSRN.

[5] 213th Report on Fast Track Magisterial Courts for Dishonoured Cheque Cases, 2008. Retrieved from 18th Law Commission of India.

[6] 230th Report on Reforms in the Indian Judiciary - Some Suggestions, 2009. Retrieved from 18th Law Commission of India.

Siddarth Raman is a researcher at XKDR Forum.

More ammo: Improving resilience against extreme surges in demand

by Ajay Shah.

The Javelin anti-tank guided missile is important for the defence of Ukraine. Under normal times, the production capacity seems to be about 3600 a year. The Ukrainians seem to be using 500 per day, or roughly one missile per kilometre of battlefront per day. The peak load is about 50 times bigger than normal times.

Vershinin, 2022 estimates the Russian army is using 7,176 artillery rounds a day, and argues that these numbers are challenging for the modern Western military manufacturing capacity. He estimates that present US annual artillery production would last for about two weeks of combat in Ukraine. In more recent times there are estimates about Russian use of as much as 60,000 rounds/day.

It may appear that with precision guided weapons, a smaller number of weapons will be required to get the job done. However, precise information about targets is lacking, and the military is reduced to shooting at numerous low probability targets. There are more pathways to target acquisition owing to drones, low earth satellites, night vision, etc., and therefore there are more opportunities to use ammo per unit time. The Ukrainian Armed Forces (UAF) innovated with their new `GIS Art for Artillery' system, where rumoured gains on the delays in the kill loop run from 20 minutes to 30 seconds. As a consequence, modern wars are facing production constraints. As an example, in the small air war in Libya in 2011, the UK and France quickly ran out of precision guided munitions (PGMs).

Such problems with the peak-to-base ratio are not unique to ammo. Consider medical oxygen. The peak load in the delta wave was much bigger than normal times. Alongside this, the bulk of the oxygen production is in the economically advanced peninsula, the biggest demand was in the Hindi heartland, and transporting oxygen is difficult as the refrigerated trucks cannot go at over 25 kph.

Or consider surgical masks and personal protective equipment (PPE). The peak demand during the pandemic perhaps went up by 50 to 100 times when compared with normal times.

Or consider medical education. With students returning from Ukraine, there was a small surge in demand for medical education in India. In a healthy economy, there should be a supply response. In a well functioning society, the resource allocation is not fixed.

Or consider electricity. Electricity demand peaks in the evening, windmills are unreliable, the sun shines in the day and can be obscured by clouds. There is substantial intra-day variation of demand (that is quite predictable), but supply is unpredictable and has a different natural intra-day variation. The puzzle of the energy system lies in dealing with the peak-to-trough ratio.

How should we think about such problems? How does the price system respond to these challenges? Is there market failure? What, if anything, is the role for the state in improving things?

Using more civilian parts

To the extent that commercial, off-the-shelf technologies ("COTS") are utilised, this eases the problem as very large sourcing can be achieved in the normal world of business. This calls for a new kind of design philosophy for military equipment, which emphasises the use of as much as possible of industrial parts that are readily sourced. This leaves a smaller problem of exotic specialised components which require special solutions for surge manufacturing.  

Surge capacity as an option

The right but not the obligation to buy is an option. When the buyer has the right, but not the obligation, to buy 2$\times$ more or 20$\times$ more from the seller, at a preset price, this is an option.

As we know from the field of options, options are always valuable (i.e. they come with a non-zero cost). Being there with excess capacity is not free, for the seller. And, the value of the option goes up when there is more volatility. While financial options loom large in the imagination, the world is full of real options.

Surge capacity in the price system

Prices move, from moment to moment, till supply equals demand. When faced with a shortage, prices go up so as to ration out many prospective buyers. And, equally, those high prices tickle firms into producing more. Vast amounts of patience and intelligence are put in, by buyers and sellers, in order to reduce demand (e.g. by finding substitutes) and increase supply (e.g. by producing in innovative ways). Every surge in prices contains the seeds of its own demise, as buyers establish alternatives, and through the supply surge that follows. Covid vaccines were always going to be a short hot market, and production is now being shut down.

When demand surges or supply drops, the price system sends out signals for firms to produce more through high prices. This tends to be accompanied by a lot of hand-wringing about shortages and high prices. If you think "something should be done", to increase output, you should be happy at what is unleashed by the price system, as there is no force more powerful than high prices, in encouraging buyers to buy less and sellers to produce more.

The market economy is not a bureaucracy; it thinks in all sorts of creative ways. If the price of oxygen is high enough, steel factories will stop making steel and sell oxygen into the public market. If prices go sufficiently high, oxygen cylinders from the Indian peninsula, and from abroad, would be airlifted into the Hindi heartland. The sources of increased supply will always surprise us.

But with the best of effort, mobilising enhanced output is hard and takes time. There is a cost to reallocating the resources of the economy, in order to shift from making widget $x$ to widget $y$. The price system finds this reallocation at the lowest cost to society, at the lowest disruption to society, without harming the incentives for sound behaviour and long-term growth.

Many times, a disruption on the output side is also a disruption of the inputs of the firm. When vast increases in output are required, the inputs (whether physical raw materials or the precise human capital) also become costlier. Both supply and demand curves change in many a surge. Such a combination of factors exacerbates the price rise.

Resilience

The price system will sort things out, in the sense of finding the price at which demand equals supply. It is interesting to go one step further and ask: How big was the supply response, of masks produced per day at its peak divided by masks produced per day before the pandemic? A more resilient economy is one where the price system induces a bigger output surge in a shorter time while requiring a smaller rise in the price.

Alternatively, we can focus on quantities and wonder, under what conditions can very large surges be achieved? We can identify a few sources of resilience.

Complexity in the production process

In a country where many things are produced, and in a country with deep pools of skilled people, there will be more headroom for adaptation. If there is a civilian aircraft industry, it can more easily retool to make military craft. If the world's biggest vaccine manufacturer is in our backyard, it can license a good vaccine from abroad and mass produce it. Tractor factories can become tank factories. For a contrast, a country like Saudi Arabia or Russia has simple structures of production, and the price system has inferior raw material to work with.

A successful software tool
is one that was used to do something
undreamed of by its author.
-- S. C. Johnson

The most important ingredient is the human capital: the managers, the chemists who know multiple routes to get to a given molecule, the creative people who can hack a machine or a software system to do things that were `undreamed of by its author'. Resilience comes from deep pools of these individuals, who are sparked into self-interested action by the price system. It is equally about the raw STEM knowledge, and about the creative thinking of the business folk who see profit opportunities, who imagine new kinds of deals, who innovate. These pools of capacity lie in the private sector. Even when a government-controlled system has the creative people, it does not have the incentives for them to think, take risks, innovate, and solve problems.

Of particular importance are adjacent products and dual-use technologies. A factory that makes vaccines can be the right starting point to rapidly get a factory to make Covid vaccines. Cylindrical engineering products made using special alloys, for civilian applications, can be rapidly retooled to make ammo. The lowest costs for augmenting supply come from the presence of these neighbours to the desired product.

In normal times, the optimal structure of production tends to become monolithic. The market tends to collapse into a small set of firms and techniques of production. Monolithic methods of production are inherently risky. When crises come along, we see the value of more diversified and more eclectic methods of production. Price surges, in a crisis, create profit opportunities for obscure strategies for production, and obscure producers. These occasional bouts of profiteering serve to keep these obscure firms, these option sellers, alive.

Private sector confidence

The private sector will stand ready with option-like capabilities, it will be alert, it will move mountains to produce when there is a price surge, all in search of one outcome: high profit rates in those brief extreme moments. A society that views supernormal profits as unjust, and tries to expropriate these private firms, is a society where private firms will layer risk premia on top of their ordinary market-based responses. In other words, we would require an even bigger price surge to elicit the supply side response when the probability of expropriation of the firms goes up.

Globalisation

High domestic prices incite imports; the productive capacity of the whole world is brought to bear upon the shortage within one country. Covid vaccine manufacturing in India was about an Indian facility that licensed a British vaccine design, and used numerous imported materials. A deep engagement with globalisation also increases resilience by fostering higher human capital of the elite. An inward oriented economy, with barriers to cross-border activities in the laws and in the minds, is likely to be less resilient.

Storage

If more ammo, oxygen or PPE are held in storage, this creates greater resilience. There is no free lunch; this storage has costs in terms of the opportunity cost of capital, the cost of storage and depreciation. Someone has to pay for this.

Production capacity that has an upside

Consider a factory that makes ammo. If the private person has a contract where there are the assembly lines and staff running at 1 shift, but are ready to jump up to 3 shifts, then there is headroom for a 3$\times$ increase in output. Sometimes assembly lines can be designed in a way where additional workers can be added and the line then runs faster. This can potentially create space for another 2$\times$ increase in output.

In the case of oxygen, firms in the field of industrial gases can have additional equipment on standby, through which medical oxygen output can go up on demand.

As with storage, there is no free lunch. The private firm would have to have contracts with skilled workers in order to be able to surge the production on demand, and design a production system with this kind of headroom. As with the `disaster recovery systems' in the world of software, the principal should randomly trigger these provisions every once in a while, and verify that each agent is indeed able to surge output as promised under contract.

Capabilities in government contracting

When there was a sudden requirement to fly students from Warsaw to India, the best pathway lies in the government rapidly running an auction, where global airlines compete to deliver the lowest price. Surge capacity for the state lies in the combination of (a) A capable and innovative private sector and (b) A state that is able to enter into contracts with private persons.

Is there a role for public policy here?

Fighting wars is a service that is produced by the government. The strategic planners in the field come up with a requirements document such as `We need to be able to sustain a war for 3 months where we are using 100 tubes a day'. Establishing this level of surge capacity is required as part of production of the public good of defence.

In the case of health, what is required is a careful counting of deaths owing to Covid-19, and assessing the number of deaths which are attributable to the shortage of medical oxygen. A careful analysis is then required, where the statistical value of a life is compared against the costs to society of higher surge capacity for oxygen. If a certain enhanced surge capacity for oxygen is able to save lives, while spending less than the statistical value of a life, there is market failure, and then there is a case for public policy to think about state action.

The fact that there is a surge in oxygen demand does not necessarily imply that there is market failure. We can envision private hospitals propositioning health insurance companies and to individuals, saying that they have established the following kinds of surge capacity for oxygen. This is not unlike the work that private hospitals do, in order to assure themselves of electricity in the event of a disaster. We should skeptically evaluate whether we want a government to do something.

Consider the field of masks and other personal protective equipment (PPE) at the early stages of the pandemic. When demand went up by 50 to 100 times, prices skyrocketed. Some policy makers were red in the face and barged into the economy, with export bans, with efforts to supplant the managers of private firms and organise production. But the right response was to do precisely nothing. High prices created near-magical responses by the private sector; there was a surge of import and production, and competition drove down prices.

State intervention that harms surge capacity

When the price system gets going, solving the mismatch between supply and demand through high prices, we often get many calls for state intervention into the working of the economy with tools like price limits and ordering private firms to operate in certain ways. It is ironic that the very feature that incites more production and reduces the demand -- high prices -- is what irritates some people.

Firms will earn supernormal profits in a surge. These supernormal profits are the fair return for (a) The hard work to modify production capacity in a short time; (b) The alertness and risk taking when faced with an incipient surge; and (c) The long years of holding option-like capabilities which are not earning high returns in normal times. When a society begrudges these supernormal profits, and uses state power to expropriate firms, the response of firms is to be less alert, take less risk, do less hard work in modifying production capacity and hold less real options, all of which worsens the problem faced by society in responding to the surge.

To commandeer resources, to order private firms, without proper compensation, is expropriation. During the second wave, many private firms were forced to stop their production in order to transfer oxygen to medical applications. If they were not compensated for their lost production, this constitutes expropriation.

Price controls hamper the very process of healing. High prices kick off the modification of the resource allocation in order to produce more and consume less. When policy makers use state coercion to force transactions to take place at artificially low prices, this reduces both responses. The one thing worse than a price that moves rapidly by a lot is one that does not.

There are always eclectic and opportunistic firms that jump into the fray and reap huge profits when a certain situation presents itself. These firms might even earn nothing at normal times, and just provide options to society. When the state interferes with the 'profiteering', their viability is adversely impacted.

State intervention that gets surge capacity at an excessive cost

One path to having the requisite amount of peak ammunition is to build a large number of public sector factories, which are idle in normal times, where the full cost of a factory is paid and the workers do nothing. While this does get the job done, it is an inefficient path; it does not harness the cleverness of private firms to get the same surge capacity at a lower price.

When there is a shortage in the country, it is tempting to ban exports. This appears to augment supply in the country, and bring down prices, in the short term. But it harms the trust of all firms to produce in India and thus harms India's long-term growth.

The Indian state attacked firms who were importing oxygen concentrators at the time of their peak demand [example]. This amplified the required rate of return for doing this important work.

The most damaging state interventions are those that directly control the resource allocation (e.g. forcing factories to close down so as to grab their oxygen), and in violating the rule of law with outright threats to coerce private persons. When the state becomes such a bull in the china shop, it tends to disrupt the complexity and sophistication of the resource allocation of the market economy. This encourages private people to produce less in India.

The discussion here, of unwise state intervention, is related to the problem of supply chain resilience when faced with Chinese exports of APIs to the Indian drugs industry. There also, it is possible to do clumsy things. Bambawale et. al. 2021 show how to do this better, how to go with the grain of the price system.

Going with the grain of the price system for surge capacity in ammunition

In the field of defence, strategic thinking should ideally generate a requirements document such as `We need to be able to sustain a war for 3 months where we are using 100 tubes a day'. Alongside this, there may be a peacetime requirement of 5 tubes a day, i.e. a peak-to-base ratio of $20\times$. This problem would get handed off to defence economics.

The best way for defence economics to solve this problem is to undertake the following kind of contract:

1. To ask for multiple private vendors who add up to a peak capacity of 100 tubes/day while actually running every day in peacetime at one-twentieth this rate;
2. The private firms would find the cost-minimising paths for obtaining this flexibility in production, and they would do this better than a PSU or a government department;
3. Each private firm would be subjected to random fire drills, where they are asked to suddenly up their production by $20\times$ for a period of $n$ days with $n < 90$.

In this procedure, we have fixed the surge capacity and are procuring on the price. Alternatively, the procurement can fix the price of the tube, and ask for bids which promise the highest surge capacity.

Through this, the energy and intelligence of the private sector would be brought to bear on the problem of obtaining surge capacity for the public goods of defence. It is better to have multiple private vendors, rather than one, so as to avoid single points of failure/attack, and to set off the spiral of quality where private firms compete with each other to deliver bigger surge capacity at a lower price.

This requires complexity in government contracting. Government contracting is a critical homeostatic capability that is required by all states, which works poorly in India. This is an important field for research.

Once contracts are in place, state actors must work within the rule of law: they must not not coerce private persons to behave in ways which were not contracted. Once the Indian state has behaved correctly for a few generations, the private sector will become more comfortable, and will require reduced safety factors in their pricing.

I thank Akshay Jaitly, Amrita Agarwal and Pranay Kotasthane for useful conversations.