Yes, there is a downturn in auto sector but who should do the fixing?

A report in this newspaper says the automotive industry is facing the worst downturn in sales in two decades. But a little bit of economics is enough to show that the headline is misleading. The economics involved is taught in the first year of any BA course. It’s called demand theory.

An important element of this is that demand can go up or down depending whether incomes go up or down. This is called the income effect. And this is what everyone, including me, has been harping on as the only reason for the drop in demand. This is the cyclical part. 

But there is another element that is even more important. It’s called the substitution effect and it happens when the item in question is substituted by something else. This effect can be broken down into two parts. One is temporary as when you replace scotch with IMFL when the exchange rate or higher duties make scotch more costly. But demand eventually picks up when incomes start to rise again. This is therefore not a matter for policy intervention because it is temporary. 

But the other effect is very different in that it is permanent and therefore structural. You simply can’t do anything about it. 

The best way to understand this is to see what happened to the demand for typewriters when computers came in. Or to tongas when cars came in. The automotive problem is not in that category. Wheels driven by motors will be around for a long time. But the presence of two things will make growth much less frantic than it has been since 2006. 

Once again there are two subsets. One is because of greater efficiency in haulage of freight. That will reduce the demand for trucks.

The other is the improvement in public transport. The coming of and expansion in metro rail and the huge increase in Uber and Ola type services means the rate of growth in demand for individualised transport will only shrink. It has happened all over the world. 

The question, therefore, is not what should be done but who should do it. The typical Indian private sector crybaby approach seeking help from the government is pointless. Even a large cut in GST isn’t going to help except at the margin for a while. 

Hence my question: if not the government, who should do whatever it is that has to be done? And my answer is that it’s the industry that must adjust to the new reality by changing the mix of its output. For taxi services it needs to produce vans of different sizes and for freight haulage, trucks of different sizes. 

This is what has happened in other countries. There is no reason why India should be an exception. Instead of industry asking the government to address the income effect, the government should ask the industry to address the substitution effect.

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