Elsevier

Energy Policy

Volume 109, October 2017, Pages 659-665
Energy Policy

Are small firms willing to pay for improved power supply? Evidence from a contingent valuation study in India

https://doi.org/10.1016/j.enpol.2017.07.046Get rights and content

Highlights

  • We find how much Indian small firms are willing to pay for reliable power supply.

  • A double-bounded dichotomous choice contingent valuation experiment is conducted.

  • Robustness tested using probit, bivariate probit and Heckman correction.

  • Firms are willing to pay 20% more to have zero power outages.

  • Crucial power sector reforms needed to negate severe impacts on small industry.

Abstract

This paper provides new estimates on Indian small-scale manufacturing firms’ willingness-to-pay (WTP) for reliable power supply. Almost half of Indian manufacturing lies in the small-scale sector, and its productivity is severely affected by power outages. However, there is a surprising paucity of research on small firms’ WTP for avoiding outages. We conduct a double-bounded dichotomous choice contingent valuation experiment with a random sample of 260 small-scale firms in the region around Hyderabad. We find that on average, firms are willing to pay approximately 20% more for uninterrupted power supply. The WTP estimates and the explanatory factors for the firms’ decisions were tested for robustness using both probit and bivariate probit models. In addition, a two-step Heckman correction was used to control for selection bias induced by protest responses. Our results are vital to understand behavior of small firms, which are crucial to India's economic growth. Further, the government's continued emphasis on power sector reforms makes the paper even more important as it provides realistic estimates for designing tariffs while keeping in mind the preferences of the small-scale industry.

Introduction

Despite high electricity rates for the industrial sector, unscheduled and scheduled power outages frequently occur in India. The lack of power supply for manufacturers causes a significant decline in output (Hansen, 2008, Hanisch et al., 2010, Allcott et al., 2016, Fisher-Vanden et al., 2015). Indeed, economic costs of power outages in the context of a developing country are substantial, with variable impact depending on industry type and country. For instance, in Sri Lanka, the costs of outages in the industrial sector can mount to 0.9% of the GDP (Wijayatunga and Jayalath, 2004). In Pakistan, overall outages reduced the GDP by 1.8% (Pasha et al., 1989). In India, Bose et al. (2006) studied the state of Karnataka and pegged the loss value in high tension (HT) industries to range from 0.09% to 0.17% of state GDP. Indian industrial productivity is particularly undermined as a result. A recent estimate suggests that the reported level of electricity shortages in India lead to a reduction in plant revenues and producer surplus by 5–10% (Allcott et al., 2016).

India's small-scale industrial sector, also known as the micro, small, and medium scale enterprises (MSMEs), bears a heavy burden of these power outages given their liquidity constraints in setting up a captive power plant (Ghosh and Kathuria, 2014). As the backbone of Indian economic growth, MSMEs employ 40% of the Indian workforce, contributing to 45% of Indian manufacturing output and 40% of India's exports (Goyal, 2013). Yet, they contribute to a mere 17% of the GDP due to poor productivity (ibid). Part of the productivity losses can be attributed to interruptions in electricity supply.1 Most of the MSMEs operate in sectors in which production is highly sensitive to electricity supply, such as food and beverages, fabricated metal products, apparel and textiles, or pharmaceuticals. Since MSMEs suffer a disproportionately higher cost of power interruptions compared to larger firms, their productivity is highly elastic to power supply. An estimation of these costs, specifically to MSMEs, therefore merits serious research.

Recent studies that engage with the issue (Allcott et al., 2016, Ghosh and Kathuria, 2014, Kim and Cho, 2017) do not single out effects of power outages on MSMEs. This dilutes the severity of its impact. Furthermore, there is little research that attempts to estimate cost of power outages by observing willingness-to-pay (WTP). In this paper, we centralize the object of our analysis as the MSME, singling out the impact on small firms in India. In doing so, we produce most recent and robust results for estimating the cost of outages.

In the literature, different methods have been proposed to estimate the cost of power outages (Baarsma and Hop, 2009). Most studies have based their estimates on observed losses in output, the cost of coping strategies, or stated preferences methods. The stated preferences method is particularly useful since it includes the full range of costs. As revealed costs for outages are not easy to discover, several studies have previously used this approach at the household level (Carlsson and Martinsson, 2007, Carlsson and Martinsson, 2008, Carlsson et al., 2011, Blass et al., 2010). While a number of studies have investigated the costs of outages in the industrialized economies (Morrison and Nalder, 2009, Baarsma and Hop, 2009, Goett et al., 2000), evidence on developing economies is sparse. Previous studies on India have focused on coping strategies and output analysis (Gulyani, 1999, Sari, 2003). These studies typically use data that do not include the full range of costs (Allcott et al., 2016, Fisher-Vanden et al., 2015). We address these shortcomings and use a stated preferences approach, namely the contingent valuation method, to estimate the full range of outage costs.

Contributing to a rather thin literature in this area, we make three new interventions in this study: first, by investigating heterogeneity in WTP for reduced power outages, we are able to distinguish WTP values for different types of MSME firms. This allows policy-makers and regulators to assess which firms should be prioritized and to what extent tariffs should discriminate between firms. Second, instead of asking ‘how much’ of a tariff would a firm be willing to pay for uninterrupted power supply, we ask ‘how much extra’ it would be willing to pay. This encourages the respondents to focus on the marginal costs (and benefits), making it a more reliable and accurate indicator of their preferences and costs. This difference leads to more realistic estimates as compared to the previous work (Bose et al., 2005). Third, we use probit, bivariate probit, and also Heckman models to ensure robust results, making the analysis richer and more rigorous.

Our findings show that firms are willing to pay 20% in addition to the prevailing tariff for a reduction of scheduled and unscheduled power outages to zero. The current estimates are significantly lower than those of Bose et al. (2006) who pegged this value at 37%. The higher conservativeness and, arguably, greater reliability of our results owes itself to the design of the present questionnaire. This will be further discussed in Section 3.

Section snippets

Survey design and data

The experiments were conducted with MSMEs in and around Hyderabad, the joint capital of the Indian states of Andhra Pradesh and Telangana. The region has over 18,000 industrial units employing more than 220,000 people, which makes it a prominent location for small and medium scale manufacturers in south India. It houses several key industrial clusters.2

Descriptive evidence

Our survey responses indicated that power outages occur on a daily basis for firms in and around Hyderabad. They are highly seasonal with summer time peaks in both scheduled (pre-announced) and unscheduled (unannounced) outages. During summer, there is low power generation from hydro plants while there is high demand for water pumping, cooling, and air conditioning (Appendix Table B.1). Firms in the region face a daily average of six hours of power outages. More than 90% of our respondents

Conclusions and policy implications

Our study augments a rather thin literature on estimating how much Indian small-scale firms (MSMEs) are willing to pay for reliable power supply. This is done using a randomized survey of 260 MSMEs in and around the Hyderabad region. Using the contingent valuation method, we show that MSMEs in the region are willing to pay 20% more than the prevailing tariffs. The results are instructive and depart from the previous work (Bose et al., 2006) in a number of ways, not only in studying the impact

Acknowledgments

We thank Philip N Kumar, Vamsi Krishna, and their team for the support in conducting the field work. We are grateful to Veena Aggarwal, Deepika Garg, Markus Hanisch, Kaushik Deb, Krithika Ramakrishnan, and Kai Rommel. We also thank two anonymous referees whose comments helped improve the paper. This work was conducted as part of the research project ‘Sustainable Hyderabad’ and financed by the German Federal Ministry of Education and Research (Grant Number: 01LG0506A).

References (42)

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