How to deter cartelization

How to deter cartelization
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First Published: Thu, May 15 2008. 10 58 PM IST

Photograph: StockXpert
Photograph: StockXpert
Updated: Thu, May 15 2008. 10 58 PM IST
Cartelization issues in the cement industry and the government’s reaction to it have been much in news recently. Neither cartelization, nor the accusations about it are new. Many of the Monopolistic and Restrictive Trade Practices (MRTP) Commission inquiries on cartelization initiated in the early 1990s are still unresolved. But that hasn’t prevented the government from threatening to revive a virtually abandoned provision of the Industries (Development and Regulation) Act, 1951, that empowers it to regulate prices and supplies of industrial commodities without bringing them under the purview of the Essential Commodities Act, a law that falls under state governments’ control.
Photograph: StockXpert
If in the 21st century India, nearly two decades after we embarked upon the path of free market, the government is wont to blackmail industry with price control, it’s a pity. At the same time, if you are going to believe that industry does not indulge in cartelization as it claims, you might as well believe that I am Queen Elizabeth.
In fact, the wish to maximize profit is as innate as the wish to avoid taxes. Just as nobody pays taxes willingly, nobody avoids price fixation or cartelization willingly. There is nothing innate in tax payments and cartelization for anyone to fall in line proactively, so that one can hardly expect self-regulation to work in situations such as these.
The old tax regime with rates at 97% levels yielded far lower collections than the latter-day tax rate of 30% combined with other systemic reforms of the liberalized era. Clearly, a liberal environment with a higher probability of being caught upon wrongdoing, coupled with a stiff consequence when caught, ensures superior compliance.
The government hardly needs to tell us that cartelization is bad for consumers. Consumers know. But what they do not need is the support of price control which, unless the demand-supply position improves, can only mean longer waiting time or black market transactions. It is a no-brainer that in a free market, the government has no case for supporting (say, sugar) or controlling (say, cement) prices. Of course, this is not to justify cartelization. That must be seriously discouraged. But, has our legal environment been conducive enough?
A World Bank Policy Research Working Paper (No. 2680 by Evenett, Levenstein and Suslow) shows that if the financial gain from cartelization (or any financial transgression, say, ticketless travel) is X and the probability of indictment is p, then in general a penalty F that is equal to or higher than “X/p” will provide the necessary deterrent. This formulation results from the reasonable supposition that to be effective, the expected value of the penalty for an action can’t be lower than the benefit from that action — this guides most penalties in developed countries, where penalties often run into millions of dollars.
But the situation in India hardly deters cartels (or much else besides). Given little probability of being indicted under the MRTP Act, 1969, cartels have always been active. What makes matters worse is that cartelization is only a civil offence, not a criminal offence. Further, with the inherent difficulties in proving cartelization, cases don’t get resolved for decades and the probability of being indicted is typically under 5%. Even in proven cases, the orders have been limited to “cease and desist” — the equivalent of requesting the erring parties, “kindly do not indulge in the act again”. The “penalties” are limited to returning the gains from the price fixation to the affected parties!
This means if you can get away with price fixing (of which the probability is extremely high), you make a killing; if you are caught, you are merely begged by the court not to do it and if you are particularly unlucky, to just return the excess profits made to the complainants. It’s heads, you win big; and tails, you lose nothing. Contrast this with other major counties, where cartelization is not only a criminal offence with heavy punitive fines and much higher rates of indictment, but CEOs are also routinely known to be imprisoned for the offence.
The Competition Act, 2002, replacing the MRTP Act, 1969, is expected to come into force only this year, thanks to some of its provisions being challenged in the Supreme Court earlier. While cartelization will continue to remain a civil offence under this Act, it provides for fines going up to 10% of turnover or three times the profit made out of anti-corruption practices — such as in the UK. Will this steeper penalty address the problem of cartelization better? Unlikely.
This is because the new Act provides for a penalty (X) at three times the profit made from cartelization. If this penalty is to be a deterrent, the probability (p) of indictment will have to be higher than 33%. If the probability is any less, the indicated penalty will not be a sufficient deterrent. A civil case dragging on for years is hardly likely to give an indictment rate upwards of one in three. The other alternative, assuming an indictment rate of a mere 5%, is to keep the penalty (X) at about 20 times the profits from cartelization. Else, it is unlikely that the Competition Act will succeed where the MRTP has failed, at least as far as cartelization is concerned.
The government’s eagerness to bring back price control seems to indicate its weak resolve to improve the probability of indictment. A high penalty then has no meaning.
All we need to do to improve the probability of indictment is undertake periodic one-time campaigns with special courts for judging cases. With a high indictment rate, a reasonable number of participants in the system would begin to comply, thus encouraging compliance at a larger scale — people tend to do what most others are doing (read Richard Thaler and Cass Sunstein’s book, Nudge).
V. Raghunathan is CEO of GMR Varalakshmi Foundation. These are his personal views. Comment at theirview@livemint.com
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First Published: Thu, May 15 2008. 10 58 PM IST