|Yes, you can auction water|
|Monday, 13 February 2012 00:00|
Critics of auctions, especially after SC judgment, don’t appreciate how flexible auction-design can be
Since water is essential, even a person with a free licence will overcharge if there is no cap on rates—don’t blame auctions for this. But if you pre-specify tariffs and then have an auction, it is fair and also protects consumers
Even before the Supreme Court judgment cancelling 122 of the licences issued by jailed ex-telecom minister A Raja (35 dual technology licences have not been cancelled so far), many like telecom minister Kapil Sibal argued that auctions hiked customer tariffs and that, while Raja may be guilty of tweaking norms to ensure favoured firms got the licence, the policy of keeping entry fees low was the correct one as it kept customer welfare in mind. After the SC judgment, a lot more worthies are making the same point, at the most conceding that while auctions may still be okay in telecom where companies are making huge profits (tell that to Bharti Airtel’s investors!), it cannot work in all cases.
There are obviously exceptions to everything, but with variations in auction design, it is possible to accommodate most situations you can think of. Three quick points before we get to the main arguments. First, even if we agree for now that auctions are a bad idea, it is still not clear how Raja’s first-come-first-served policy works better. Linked to this is the second point, that auctions don’t decide customer tariffs, competition does—Vodafone paid $11 billion for Hutch’s India operations, but it never raised its tariffs for several years till now when competitors like Bharti Airtel raised them. What follows is the third point, that even if companies go bust because of irrational bidding, it doesn’t affect customers—if Vodafone found that it wasn’t viable to run the business having paid $11 billion, it would simply exit the business by selling to Bharti Airtel at, say, $4 billion (assuming that, at this price, it would be viable) and its shareholders would absorb the hit.
Let’s take the most extreme case of water which is so essential you’d pay anything to get it. If you were to auction water, the argument goes, the rich would drive up prices and the poor would never be able to afford it. That’s really awful but the question is whether it is true. The rich are such misers, they will pay high prices only if there is a shortage of water—in such a situation, how will you distribute water to people if you don’t like auctions? By rationing. But you can ration using auctions as well. Here’s how: Before you conduct an auction for the city’s water franchise, put in a condition that says every household must get 1,000 litres of water a day, there must be at least 6 hours of running water in each area, 35% of water must go to the slums … (just keep adding any conditions you want). Oh yes, do specify that one litre of water cannot be sold for more than 5 paise. The bidder who wins can then pay any price—the more onerous the conditions, the lower the bid price—but consumer tariffs will remain low. And here’s the counter question: If you give out a franchise for free on a first-come-first-served basis or any other you can think of, how does this prevent the franchisee from raising consumer tariffs? It doesn’t. What prevents this is credible government legislation if it is a monopoly we’re dealing with—where there is competition, that automatically puts a cap to tariffs, as we’ve seen in telecom.
That sounds good but where does this get implemented in real life? In the roads sector, India has a ceiling toll that can be charged and investors bid knowing full well about this. In telecom, electricity, airports, ports and so on, bids are made knowing the regulator will decide tariffs, not the providers.
But, the argument goes on, bids discriminate against small chaps, nor do they help get the best person since only the ability to pay is what matters in bids. Again, that’s not quite true. India’s largest telecom player, Sunil Mittal, was a minnow compared to the Ambanis and Tatas way back in 1994 and, in the airport sector, GMR and GVK were relative lightweights compared to Anil Ambani. In any case, even if you assume that up-front bids (R16,751 crore for an all-India 3G bid) keep away the small boys (though you do have PEs and banks willing to fund them), revenue-share bids do away with this—GMR didn’t win the Delhi airport by bidding a huge upfront payment, it just offered to pay the highest share of its annual revenue.
As for getting the best companies to participate, most bids have a two-stage technical-and-financial evaluation stage. In the Delhi and Mumbai airport bids, companies were chosen on their technical capabilities and only those that qualified were asked to bid.
Okay, but this cannot apply to all natural resources in the manner the SC suggests it should, the anti-auction brigade perseveres. In the case of iron ore or coal mines, for instance, the government is concerned not just about getting the highest revenue for ore and coal, it needs to ensure power and steel producers get raw materials at reasonable prices. And, in any case, think of the taxes the government gets from the power and steel producers—this is also the argument made by political parties to keep out merchant miners, for instance. Once again, the logic is seductive, but misses the point. For one, not all steel/power producers have captive mines but they still remain profitable—in a shortage situation, captive mines just mean large profits for one group of producers. Second, while it’s true the government earns more excise duty from steel production, this gets made up by the much larger corporate tax it gets from mining companies which tend to be a lot more profitable than steel producers—in 2009-10, for instance, mining firm NMDC gave 47% or so of its revenue to the government as compared to around 12% for steel PSU SAIL.
The clincher, though, is what happens to a country’s reserves when mines are bid out to merchant miners. In 1980, India had 11.5 billion tonnes of iron ore reserves and Australia 15 billion; in 2005, India was 13.8 billion and Australia 40 billion! Australia has commercial miners while India is stuck on captive mines. In 2010-11, Australian miners invested $5.9 billion in new exploration and $56 billion in new capital expenditure on existing mines—the $174 billion Australia had invested in mines in April 2011 was a 31% hike since October 2010!
Cut to the Raja licensees and you see this best. Of all the firms that got the licences, Uninor did the best because, once Telenor had paid Unitech R6,120 crore for a 67% stake in the business, it just had to get those customers.
Slice it anyway you like, there’s no getting away from the fact that auctions are the best policy (not just the most transparent) when there are more claimants than there are goods to be distributed. And, once you have your policy objectives clear (cheapest telecom services, for instance), auctions can be modified to accommodate them.