To auction or to allocate?

A disingenuous argument is that a wrong decision, which causes a loss to the public exchequer, is as such criminal. This is a dangerous claim
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First Published: Tue, Oct 02 2012. 07 21 PM IST
In the spectrum and general coal allotment case, the input price becomes a sunk cost and hence is not a factor in output pricing, and hence they should have been auctioned. Photo: Noah Seelam/AFP
In the spectrum and general coal allotment case, the input price becomes a sunk cost and hence is not a factor in output pricing, and hence they should have been auctioned. Photo: Noah Seelam/AFP
The allocation of coal blocks and the previous allotment of 2G spectrum have been the subject of controversy for a while now. Until the other day—that is before the Supreme Court delivered its advisory opinion—the dominant view was that all scarce natural resources should be auctioned, otherwise the allocation would be tantamount to causing loss to the exchequer. This line has been followed by the Comptroller and Auditor General and even endorsed by the apex court in its judgement in the 2G spectrum case. The Supreme Court explained that it was in the context of the allotment process being vitiated by arbitrariness and malafide intent, that it suggested that “all” natural resources should be auctioned. The court’s advisory opinion rectified the matter.
A related but more disingenuous argument is that a wrong decision, which causes a loss to the public exchequer, is as such criminal. This is a dangerous claim. All people make mistakes and as the saying goes “to err is human” and some people are simply more human.
Even in the UK, 2G spectrum was not auctioned and was sold by what economists call contemptuously, a beauty contest. It fetched a poor £40,000; years later, when the government there sold 3G by auction, it fetched record revenue of £22 billion. But no one went after the government, with the benefit of hindsight. Such a persecution mania is the cause for government machinery grinding to a halt in decision making.
It is important to examine the merits and demerits of auction compared with allotment. The proponents of allotment argue if they followed the auction route, that would substantially increase the price of the end product be it a telephone call or electricity as these are dependent on the use of coal and spectrum.
Ex-minister A. Raja and minister Sriprakash Jaiswal made this argument. Even former disinvestment minister Arun Shourie, advised by the then chairman of the Telecom Regulatory Authority of India (Trai) Pradip Baijal, used the same argument in allotting spectrum. It can be argued that Shourie, Baijal, and Raja were wrong, but Jaiswal was, partially right. He was right in justifying allotment of coal for ultra mega power projects (UMPP), but not right in case of other general allotments.
This argument assumes that a high input cost will necessarily be passed on as a high output cost. This is not true in all cases, and one needs to understand when a high input cost will be passed on and when it will not/cannot be passed on. The critical question to ask is when the input is purchased and when the output is sold. In the case of spectrum, the firm buys the spectrum in the hope of making use of it to serve a large number of consumers. Once it buys, the investment on spectrum through the one-time lump sum payment becomes a sunk cost and is no longer relevant for pricing phone calls. If there is no competition and therefore no undercutting, the firm can extract the maximum willingness to pay on part of a consumer and can recover much more than the spectrum cost.
In contrast, if there is competition, and consequent undercutting, there is no way to recover the sunk cost spent on spectrum, and the firm has to be content with getting large number of consumers and charging a price based on what the competitor charges and try to make a small margin over variable cost, to cover the fixed cost.
Therefore, in either case, fixed cost recovery is not a relevant decision rule; under monopoly you can recover more than fixed cost and under competition, you may not be able to recover anything at all, unless there is collusion.
The case of coal allotment is slightly different. Here there are two different cases. One, a general allotment without any conditions, and two, a specific allotment to the successful bidders of the electricity generation in the UMPP framework. The first instance is similar to the one in the 2G spectrum case and indefensible. But in the second case, the fact of allotment was factored into the competitive bidding of power, whose price has been held constant for 25 years. Before bidding for the cost of power, the bidders were told of the allotment, and thus the price of coal was not a sunk cost, but a cost which weighed in their bidding. After all, in Sasan UMPP, the entire sector discovered the world beating price of Rs.1.19 per kwh, only because of the allotment of the coal block, forcing the competitor to cut costs, which lead Lanco—and later Reliance—to source the equipment from China and lower the bid price. Thus, in this case a low input price did lead to a low output price. This is an excellent example of how decisions will be different under sunk cost and relevant cost situations.
In the spectrum and general coal allotment case, the input price becomes a sunk cost and hence is not a factor in output pricing, and hence they should have been auctioned. In the UMPP case, coal price is still a relevant cost, and so allotment without auction, could not have resulted in any loss; the consumer would have benefited in the form of lower electricity price.
V. Ranganathan is a former member of Trai and a professor of economics at the Indian Institute of Management, Bangalore.
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First Published: Tue, Oct 02 2012. 07 21 PM IST
More Topics: Views | coal | 2G | UMPP | A. Raja |
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