The work in microeconomic theory for which Oliver Hart and Bengt Holmström have received this years Nobel Prize goes back to the 1970s and 1980s when the foundations of contract theory were being firmed up.
Their work has provided economists the tools to understand interactions between entities in a range of fields, such as the design of performance incentives in firms and schools, corporate governance, privatisation, constitutional law, and entrepreneur-investor relationships.
The Royal Swedish Academy of Sciences highlighted that their contributions to understanding “real-life contracts and institutions, as well as the pitfalls when designing new contracts” were crucial.
Mr. Holmström, in 1979, published a theoretical model and result that significantly enhanced the understanding of risk and incentives in employer-employee relationships.
This was called the informativeness principle, which said performance should be linked to all variables or outcomes that provide information on the actions taken by an agent, such as a firm’s manager, and not just the outcomes she can effect.
Remunerating a manager based on just the share price of her firm will reward and punish her for factors beyond her control, and a better contract would therefore link managerial compensation to the firm’s share price relative to the share prices of other comparable firms.
Mr. Hart’s key contribution to contract theory has been the notion of incomplete contracts. Not all information is available ex ante; how does a contract allow principals (such as employers) and agents (such as employees) to negotiate unforeseen situations?
The work by Mr. Hart and his colleagues in this area was cited by the Academy for its breakthrough nature.
The Economics Nobel raises larger questions given the high-profile nature of the subject and the fact that it is the only social science for which a prize is awarded. Analysis from The Economist and the Nobel organisation shows that of the 77 laureates who shared the 48 economics prizes awarded between 1969 and 2016, all of 38 were U.S. residents and 10 were British.
Economic historians Avner Offer and Gabriel Söderberg recently pointed out that while the prize may not have a significant liberal or conservative bias, only one person has been awarded a prize for ‘social democracy’ — how governments provide for their people — as opposed to ‘hard economics’ despite social democratic principles governing how 30 per cent of GDP is allocated in developed countries.
Why this has happened is perhaps less important than pointing out that it has happened, so there is an awareness of what the economics prize is, and what it is not.
Contract Theory:-
Contract theory is not merely the study of legally binding contracts. Broadly defined, it studies the design of formal and informal agreements that motivate people with conflicting interests to take mutually beneficial actions. Contract theory guides us in structuring arrangements between employers and employees, shareholders and chief executives, and companies and their suppliers.
In essence, contract theory is about giving each party the right incentives or motivations to work effectively together.
Previously, general equilibrium theory had already shown how efficient outcomes can be achieved under ideal circumstances, through detailed contractual agreements. In fact, research in this area has already led to a number of other economic science prizes.
However, this research ignored two potential issues: informational problems and incomplete contracts. By studying these two issues, Hart and Holmström developed what has become modern contract theory.
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Petrol in India is cheaper than in countries like Hong Kong, Germany and the UK but costlier than in China, Brazil, Japan, the US, Russia, Pakistan and Sri Lanka, a Bank of Baroda Economics Research report showed.
Rising fuel prices in India have led to considerable debate on which government, state or central, should be lowering their taxes to keep prices under control.
The rise in fuel prices is mainly due to the global price of crude oil (raw material for making petrol and diesel) going up. Further, a stronger dollar has added to the cost of crude oil.
Amongst comparable countries (per capita wise), prices in India are higher than those in Vietnam, Kenya, Ukraine, Bangladesh, Nepal, Pakistan, Sri Lanka, and Venezuela. Countries that are major oil producers have much lower prices.
In the report, the Philippines has a comparable petrol price but has a per capita income higher than India by over 50 per cent.
Countries which have a lower per capita income like Kenya, Bangladesh, Nepal, Pakistan, and Venezuela have much lower prices of petrol and hence are impacted less than India.
“Therefore there is still a strong case for the government to consider lowering the taxes on fuel to protect the interest of the people,” the report argued.
India is the world’s third-biggest oil consuming and importing nation. It imports 85 per cent of its oil needs and so prices retail fuel at import parity rates.
With the global surge in energy prices, the cost of producing petrol, diesel and other petroleum products also went up for oil companies in India.
They raised petrol and diesel prices by Rs 10 a litre in just over a fortnight beginning March 22 but hit a pause button soon after as the move faced criticism and the opposition parties asked the government to cut taxes instead.
India imports most of its oil from a group of countries called the ‘OPEC +’ (i.e, Iran, Iraq, Saudi Arabia, Venezuela, Kuwait, United Arab Emirates, Russia, etc), which produces 40% of the world’s crude oil.
As they have the power to dictate fuel supply and prices, their decision of limiting the global supply reduces supply in India, thus raising prices
The government charges about 167% tax (excise) on petrol and 129% on diesel as compared to US (20%), UK (62%), Italy and Germany (65%).
The abominable excise duty is 2/3rd of the cost, and the base price, dealer commission and freight form the rest.
Here is an approximate break-up (in Rs):
a)Base Price | 39 |
b)Freight | 0.34 |
c) Price Charged to Dealers = (a+b) | 39.34 |
d) Excise Duty | 40.17 |
e) Dealer Commission | 4.68 |
f) VAT | 25.35 |
g) Retail Selling Price | 109.54 |
Looked closely, much of the cost of petrol and diesel is due to higher tax rate by govt, specifically excise duty.
So the question is why government is not reducing the prices ?
India, being a developing country, it does require gigantic amount of funding for its infrastructure projects as well as welfare schemes.
However, we as a society is yet to be tax-compliant. Many people evade the direct tax and that’s the reason why govt’s hands are tied. Govt. needs the money to fund various programs and at the same time it is not generating enough revenue from direct taxes.
That’s the reason why, govt is bumping up its revenue through higher indirect taxes such as GST or excise duty as in the case of petrol and diesel.
Direct taxes are progressive as it taxes according to an individuals’ income however indirect tax such as excise duty or GST are regressive in the sense that the poorest of the poor and richest of the rich have to pay the same amount.
Does not matter, if you are an auto-driver or owner of a Mercedes, end of the day both pay the same price for petrol/diesel-that’s why it is regressive in nature.
But unlike direct tax where tax evasion is rampant, indirect tax can not be evaded due to their very nature and as long as huge no of Indians keep evading direct taxes, indirect tax such as excise duty will be difficult for the govt to reduce, because it may reduce the revenue and hamper may programs of the govt.