Wednesday, June 27, 2012

Price Cartelisation !

Why Competition?
As you know India was a socialist state from 1950 till around 1990, when it tried to industralise by keeping PSUs at a commanding heights and stifling the private cos, which came to be known as 'The License Raj'. It was bound to fail and it did. As of 1991, our forex stood at $1.2 Billion and BoP was in such a mess that we had to literally airlift gold bars lying in our reserves to pledge it with the Bretton Woods for some credit.

Faced with bankruptcy, wisdom dawned upon our policy makers and they put the "mujhe muh nahin kholna"(dentist ke samne bhi nahin? ), our blue turbaned "paaji' at the helm of affairs. Starting 1991 India made U-turn in its socialist ideologies and through various LPG measures, established a 'market oriented' 'Capitalist economic system, and became the 2nd fastest growing economy in the world. Yesterday, India committed to helping IMF with $10 Billion in its Europe Firewall Fund !! The wheel has indeed turned full circle !! 
Proud Indian Here !! 

Central to this economic system is the feature of 'competition', which at times can be corrosive.For any free market to effectively function there should be healthy competition amongst the firms participating in that market. It is the market which determines the price of the product, through its demand and supply forces. [Remember the demand and supply curve and the point where they intersect, determines the equilibrium price]

Competition is an economic stimulant which is good for the consumers(as they get lower price, better quality, more variety), government and ultimately lead to consumer welfare. Government control over any product is not good as it ultimately lead to inefficiencies, wastage and loss. Hence the abolition of 'administered pricing mechanism' for petrol etc. It has been argued by several economists that Govt. should not interfere in the regular functioning of the market and should only be regulator, facilitator and should only interfere when there is an issue. Say, there is drought in country and production of sugar has been less. Govt. can impose heavy export duty to discourage sugar leaving Indian shores etc. 
[Note: Sugar Market in India is NOT exactly a free market and is a regulated item under the Essential Commodities Act]

Lack of competition invites several corrupts practices and costs a lot to the exchequer. In certain situations (like procurement of goods & services) state govts. follows the policy and practice to give preference to local units in their procurement policy. So price and purchase preference is given to small scale sector cos., so as to protect and promote such units. From dev. perspective it may be fine but it creates enough conditions for these units to collude and cause serious loss to the exchequer. 

While doing initial study for my latest post on Health Sector in India (See here), I found out how these local traders(colluded with hospital staffs) and looted govt. 
Some examples:
> Purchasing of Non Essential Drugs – Nimesulide Tabs 18% of budget !!!!! (BTW Nimesulide is now banned in India or ceased to be OTC drug ?)
> Dialysis machine worth 5 lakhs bought for around 13 lakhs !!
> Equipment for removing Cholesterol was bought for 60 lakhs and used only once !! (OMG !! heights )

All of these happen because there aren't any competition in such procurement models !! Economic resources(including natural resources) are always be scarce and Govt. should always try and see that its distributed optimally and in most efficient way. Hence, increasingly govt. policies are framed and implemented to promote competition and level playing fields for all. 

Basic Concept:
The main aim of any company is profit maximisation for its shareholders. There is a purpose to economic activity and this was identified long back when ancient Indian posted Artha, ‘material well being’, as one of the goals of life. They believed that the pursuit of money is justified to the extent that it leads to the good life. However this desire to maximize one's profit has taken a disproportionate dimensions and companies often indulge in malpractices. As Adam Smith puts it, if at all cos. gather, they do so "to conspire against the public, or some contrivance to raise prices". 

Such companies usually form two types of arrangements - horizontal(peers) and vertical(with one below in value chain).

Cartels are basically a type of 'secret horizontal arrangement' b/w 'peer companies' to achieve gain for themselves. Such type of arrangements discourage 'competition'. 

Cartels usually forms in a conducive environment when ...

> the market is Oligopoly, where there are few dominant players, and; 

> there are high entry barriers - there is very less incentive for any new player to enter the market
(See Porter's 5 forces model for details). [Indian cellular market had high entry barrier but still the Nordic tele major 'Telenor' entered Indian market, which surprised many. Ultimately it had to face huge losses and exit the market]

> the product demand is inelastic - Since their ultimate motive is to manipulate price, which if increased will lead to fall in demand, thereby reducing their revenue. All such issues would not be with inelastic demand product as no matter the price demand is not affected much. 

Cartels can be formed in following 4 types:

(i) through price fixing 
Some examples - 
> the cartel members decide to increase price of product simultaneously
> simultaneously apply uniform discounts on products
> agree among cartel members on a standard formula, according to which product prices will be determined
> agree to remove products offered at low prices from the market so as to limit supply and keep prices high

(ii) market sharing
agree amongst cartel members and divide markets by territory or by customers

(iii) limiting output 
companies limit the supply and create artificial demands in market. [Recent onion price hike(when sulphur in onion wasn't the reason for our tears) was considered to be result of one such illegal cartel activity]

(iv) bid rigging
companies conspire in private to intentionally and collectively quote less for a tender, thereby driving down the price. Govt. is leaving no stone unturned to ensure that the forthcoming 2G auctions are free of any such bid rigging through various intelligence and other measures. 

All these types of cartels ultimately gives the power of 'deciding prices' to select companies who join the cartel. 

Govt. of India has taken various measures to curb such cartelization. MRTP Act had been protecting the interests of consumers, but with changed global scenario and the WTO commitments of India and the various Free Trade agreements its signing with various countries, new Competition Commission of India (CCI) was formed in 2002. 

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