A recent report by the Comptroller and Auditor General (CAG) has reportedly suggested that the government lost a whopping Rs 10.67 lakh crore between 2004 and 2009 because it did not auction coal blocks. (The CAG has since called the reports “extremely misleading”.) To come to this figure, the CAG apparently did the following calculations. It calculated the costs of producing coal in similar government mines and subtracted this amount from the price of the coal to get the profits per unit of coal. It then multiplied this amount by 90 per cent of the total amount of coal in these blocks to get the total profits made by the companies that were given these coal blocks to mine. The figure of 90 per cent was to allow for various slippages in production, and the margin per unit of coal (price minus cost) was calculated on the basis of the price for the lowest grade of coal. In other words, assuming that all costs were taken into account including the alternative costs of capital, the revenue loss to the government as calculated by the CAG is the minimum amount of the loss. The actual loss could be even higher.
There are two issues here. First, is the calculation right? The non-trivial question here is not whether the arithmetic is right, but whether the principle is right. I am not going to go into the arithmetic since accountants can do a much better job than I. As far as the principle is concerned, there are two parts to it. One part concerns the efficacy of using market prices and government costs of producing coal. The other part is about whether this should be considered a loss to the government. After all, what the government has done is transfer value that was notionally held by everybody to some specific parties, who have now realised that value. Who knows if that value was appropriated by the government, it would have been better utilised than by the companies. Second, and what is of interest to me, is whether this loss could be avoided if the government had auctioned the coal blocks.
There is a very fundamental issue here. Should natural resources be considered a property of the “government” or of society? If the latter, why should it be sold at all to raise resources? After all, any such sales would be a pure transfer, especially if the government was to take away the entire surplus that a private party – or any buyer from within that society – could make. One argument that could be made for selling the natural resource was that the government could utilise the surplus better — for building infrastructure, for example, which the buyer of the resources will not do.
So, we come back to whether it should be auctioned. There are three main criticisms against auctions. First, our markets are not robust enough to hold auctions that prevent collusion or rigging of bids. There is enough material in the literature on auctions regarding how to prevent, or detect, such collusive behaviour. This, therefore, is not a valid criticism unless one can show that the collusive behaviour they are thinking of cannot be blocked by any feasible design of auctions. Second, auctions will prevent entry since many efficient entities will not have the initial money power to pay the price upfront. This is a problem of financing and not auctions. Indeed, in India, there are many instances of auctions of land in various states where once the bid is won by a party, there is a certificate of ownership given by the government. This certificate allows the winning party to take a loan from a financial institution to pay the price within a stipulated period of time.
The third criticism is that if the highest bidder wins the auction, the winner will try to recover this from the consumers — and this will increase the prices of the goods and services that are expected to flow from the utilisation of the natural, or national, resource. This is something I fail to understand. In a competitive set-up, as in the case of coal, if the prices are too high, consumers will not buy from this highest bidder — and unless the bidder is stupid, it will know of this possibility. Hence the bids will reflect the competitive pressures.
In all fairness, however, the critics refer to markets where the ultimate winner in an auction will act as a monopolist in a segmented market rather than being a competitor. The argument is that the monopolist will again try to recover the bids by charging higher prices and, since there are no competitors, the disciplining mechanism of competition discussed in the last paragraph will not work to avoid unnecessarily high bids — hence, high final prices. As a first course in economics tells us, revenue to a monopolist is the price times the amount sold, and the amount sold (at any price) is what the demand curve will bear. Thus, monopolists can choose either price or quantity, but not both. This first course also tells us that the profit-maximising quantity for the monopolist is where the marginal cost (given by the technology and cost of inputs) equals the marginal revenue (derived from the demand curve).
Most importantly, the upfront fee paid in the auction does not affect the marginal cost and, of course, the demand curve or the marginal revenue. In other words, such pricing imperative, or quantity strategy, will be unaffected by the bid price as long as positive profit is made after deducting the bid price. So, there is no reason to believe that unnecessarily high bids will be made during the auction — or that the price will be low if the amount paid for outright purchase of natural resources were low!
The writer is research director at India Development Foundation and the director of the School of Humanities and Social Sciences at Shiv Nadar University
