Tag: auctions

Categories
Economics Politics & government

[2642] They should have auctioned it

The state — or in common parlance, the government — is the guardian of public resource. These resources are ones that we own collectively, like petroleum, or of interest in the past few weeks in Malaysia, telecommunication spectrum. It is the responsibility of the government to manage and use the resources efficiently. If it cannot, then there is a case to privatize those resources to those who can.

In privatizing these resources, one would expect the government to raise some money it can use to improve the general welfare of the public. One of the best ways to raise money from such privatization is by auctioning the public resource.

Economists typically love auctions because it is efficient. In everyday English, it means an auction can extract the most benefit out of a transaction for the seller. In an auction that focuses purely on maximizing sale prices, the government will benefit enormously from the outcomes of the auctions.

In the Netherlands recently, the government raised nearly EUR4 billion by auctioning the 4G spectrum to the private sector. Initially, the government had expected to raise half a billion euro only. The large difference came as a pleasant surprise to the government. In time when the Dutch government is tightening their belt as a reaction to the economic crisis that Europe as a whole is facing, the EUR4 billion will help in maintaining the quality of public service in the Netherlands.

If one is concerned whether such privatization and auctioning would create a monopoly, there are types of auction that can address exactly that. Restrictions can be imposed so that nobody can buy everything, or buys too much. While total receipts out of those auctions may suffer, the government will still enjoy considerable revenue out of it that can put to good use.

One example will bring us to the United States in 2008 when the Federal Communications Commission (FCC) conducted a controversial spectrum auction. Restrictions were imposed to prevent telecommunication firms from gaining too much market power. Google, worried that these telecommunication firms would restrict access to various content and applications on the internet, even decided to participate in the auction despite not being a telecommunication firm per se. After all had been said and done, the FCC still raised nearly USD20 billion from that particular auction while addressing the issue of market power.

In contrast in Malaysia, 4G spectrum was transferred from the public domain to private firms for free. There was no sale at all, and much less an auction.

For the public, the privatization is an outright welfare loss. An asset that could have been worth billions of ringgit of public money ended up as being nothing.  There is no new revenue for the government and so, the public cannot benefit from the privatization exercise as much as it should. And this comes at a time when the government recognizes that it needs to broaden its taxpayer base, which is narrow at the moment. So, the privatization will not be popular to discerning taxpayers.

Even libertarians, who would typically support privatization exercise, will find this particular Malaysian privatization as very disappointing.

Despite the fact that the privatization came at the expense of potential revenue for the public, some would no doubt defend the flawed privatization. Several defenses have been presented so far.

One argument suggests that with the free award, the recipients would be able to provide cheaper services with the same level of quality than they otherwise could. This is not a given unfortunately and right now, it is a mere speculation.

The reason is that these recipients can effectively form a cartel. This has happened in the past, even with the new Competition Act is in place. In fact, Maxis and Redtone International, two of the 4G spectrum recipients, are already collaborating in rolling out their 4G network. How far this particular collaboration will go is for all of us to see.

Worse, some could even essentially resell the spectrum to other more serious telecommunication companies instead of utilizing the spectrum for themselves. In doing so, they would realize the economic rent that should belong to the public in the first place. If there was an auction or even just a sale instead earlier, there would have been less opportunity for such rent-seeking activities. An auction especially would have squeezed the incentive for rent-seeking out into public pocket and force firms to try to create new wealth rather than engage in unproductive rent-seeking.

Unfortunately, now that everything is done, we are left with the possibility of collusion in the market and a whole lot of room for rent-seeking activities by private firms at the expense of the public. This is not an ideal market scenario.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in The Sun on December 25 2012.

Categories
Economics

[2599] Don’t auction it. Abolish it

Let me begin by stating that I support a significant cut in in duties and taxes on cars.

There are at least two reasons for that. One, the cut will allow market forces to work better so that we can have a more efficient environment. A simpler market arrangement will free up resources dedicated to an elaborate system that was initially designed to protect the domestic car industry at the expense of Malaysian consumers. Two, the cut will enhance consumer welfare, which is in some ways a restatement of the first rationale. It improves welfare because with cheaper cars, the same personal resources used to purchase cars can be used for something else.

Along the same vein, I also support the abolition of approved permits.

Theoretically, permits can make the market more efficient but only in the cases of market failure. Permits help redistribute resources better when the market cannot self-organize due to cost being individually unaccounted. When there is no market failure, a permit system causes inefficiency. Indeed in the domestic car market, the permit system adds to the cost of a car, adding inefficiency to the system. I do not see any market failure in the car market and so, in the name of efficiency, approved permits should go the way of the Proton Juara.

I am not the first to say this because the issue is not new. It has always been talked about in the background but it is only recently that it gained very public attention and it is all because of Parti Keadilan Rakyat’s Rafizi Ramli. He has been consistently raising it in the way that it forces the government to reply. The fact that the national election is around the corner, somewhere out there, helps too.

Putting the issue to the middle of the table is good. It is good because it raises the profile of a real and significant issue that affects welfare of Malaysians. Now we have one more policy debate and it is something concrete to talk about, away from the typically unfulfilling issues of race and religion that most times are superficial. That alone gets the thumbs up from me.

Rafizi proposes to make passenger cars in the country more affordable by eliminating or reducing the high duties and taxes imposed on cars. I do support that.

The latest turn in the debate revolves around the approved permits for cars. It is here where I find his position on the matter disagreeable.

He proposes to auction the permits and sell it to the highest bidders. That has caused him to be criticized by those supporting the status quo, others are against it as it is inconsistent. If the permits are auctioned to the highest bidders, then car prices will go up. This will be contrary to the aim of making cars more affordable.

He defends his proposal by stating that the abolition of duties and taxes on cars will ensure that the total price of car will be lower even with auctioned permits. How is that so? He asserts that the permits at the moment fetch prices between RM40,000 and RM60,000 and so, he expects that the same price levels will prevail in an open bidding system as well. This is the assumption that allows him to mount a defense against the criticism. He assumes every cost component as constant except for duties and taxes, which are significantly reduced or eliminated.

In my opinion, the criticism against Rafizi is justified and his defense is no defense. The reason is that his assumption of everything being constant but duties and taxes cannot hold. The reason is that there is no guarantee that the permit price must be in the range he stated.

An auction is a very efficient method at ensuring that the seller gets to sell his goods or services at the highest price possible. And if there is enough demand for permits while supply is limited, then ceiling price can be as high as the sky.

We do not know how high the bid price for permits can go right now. We can only assume and Rafizi assumes that the price range he cites is the benchmark.

Unfortunately, his assumption depends on one question: is the price range cited the result of open bidding among many auction participants, or a negotiated outcome within a small circle?

It is very possible that it is the latter. In the latter case, there is every reason to suspect that the price range cited is too low. Have an open tender instead and microeconomics will work its magic to push that range up to the appropriate level. I do not know how far up it can go. For all I know, the permit price can go up high enough that it may undo any reduction in car price resulting from the abolition of car duties and taxes. The only way to find know is to actually run an auction for the permits. Now, there is context to the auction debate. Those against the effort to cut duties and taxes on cars are worried about government revenue loss. Rafizi counters that that concern can be addressed by auctioning the permits. He is right about how an auction can address the worry, given how the current distribution system of permits is at best inefficient (since the government does not get the full value of the permit), and at worst corrupt.

There are other ways to address the concern about government revenue loss while being consistent with the objective of making cars more affordable. Auctioning the permits is just not one of those consistent solutions.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in The Malaysian Insider on September 21 2012.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
n/b — for economic literates, this was written with quota quantity (or its relative quantity to total cars in Malaysia) unchanged. With significant increase in the number of quota, it’s possible for prices to fall even with auctioned permits under perfect competition and perfect pricing. If the quota remains unchanged and auctioned, no cut in taxes and duties will reduce prices. In fact, prices will remain the same in theory.

Categories
Economics

[1124] Of moderating the FTA-related drug prices increase

It is March and the deadline to forge a free trade agreement between Malaysia and the United States is looming closer. Here, I want to share a solution that could lay a middle ground between the supporters and the opponents of the FTA as far as drug prices are concerned.

Firstly, it is good to recognize why the prices of drugs could go up if the free trade agreement is signed. The increase is exclusively due to stronger intellectual copyrights law and not due to the principles of free trade. Though a majority of us, including me, does not know the exact detail of the FTA, there is enough information flying out in the public to be sure of that. With stronger copyrights law, cheap generic drugs would not be allowed to be sold as widely as it is available at the moment, in favor of patented drugs. Makers of patented drugs would be able to enjoy higher sales for longer period without the risk of competing with cheaper generic drugs.

While I generally support freer trade, I do sympathize for individuals that would be adversely affected by higher drug prices. Nevertheless, it is imperative for us to respect private property and directly, incentive for innovation. Between the two factors, a dilemma. The dilemma must be solved if the Malaysia-US FTA is to become acceptable to as many Malaysian as possible.

Here is what I propose to solve the dilemma: there is a role for the government. The Malaysian government could buy drugs from pharmaceutical companies and then resell it to the public through public health infrastructure at cost.

I know, I know. Anybody that is familiar with this blog would not expect me to propose a statist solution. Before you bang in the head however, please read on.

The program that I am thinking of might be distantly similar to what is practiced in Australia while stopping short at down right subsidy. The Malaysian government could buy drugs through auction and I am thinking reversed modified Dutch auction.

I am unsure if reversed Dutch auction is a common economic term for the kind of auction I have in mind but a Dutch auction works like this: there are a seller and many buyers. For simplicity and clarity reason, I shall call the seller as the auctioneer while the buyers as bidders. The auctioneer begins the auction by placing a high ask price. The price will be lowered by the auctioneer if there is no buyer. The auctioneer will continue to lower the price until there is a willing buyer. A variation of this auction was practiced during the initial public offering of Google back in 2004.

A reversed modified Dutch auction, as I call it, is a scenario which there are a buyer and many sellers. The buyer is the auctioneer while the sellers are the bidders. In a sense, reversed Dutch auction is the opposite of Dutch auction in the way monopoly is the opposite of monopsony.

Within Malaysian context, the Malaysian government is the auctioneer while various pharmaceutical companies of patented drugs are the bidders. The government starts by placing a low ask price in the free market. If there is no willing seller at such a low price, the government will increase its offer price and will continue to do so until there is a willing seller. The government could continue to do so until all of its demands are met. An example might help illustrate what I am trying to get at. Say the Malaysia government is demanding 1000 tons of drugs. At the same time, there are five sellers which I shall call A, B, C, D E and F.

Company A is able to supply 300 tons at RM1.00 per kg.

Company B is able to supply 300 tons at RM1.50 per kg.

Company C is able to supply 200 tons at RM2.00 per kg.

Company D is able to supply 100 tons at RM2.50 per kg.

Company E is able to supply 100 tons at RM3.00 per kg.

Company F is able to supply 100 tons at RM3.50 per kg.

The first 300 tons will be fulfilled by Company A and the government will pay RM1.00 per kg for drugs. This leaves 700 tons of unfulfilled demand. Realizing that nobody is willing to see any drug at RM1.00 anymore, the government raises it ask price and eventually will hit RM1.50 per kg. At that moment, Company B will step in and supply the government will 300 tons of drugs at such price. This leaves 400 tons of unfulfilled demand. The process will continue until the demand is exhausted. In this particular scenario, the government will pay at RM3.00 per kg at most; the government will not buy from Company F.

While prices could still increase vis-à-vis prices without the FTA, the increase would not be as much as that without this model with the FTA. If the drug prices are not low enough, perhaps the government could add in some sort of subsidy into the equation by selling the drugs bought at a loss. I however would only agree to such arrangement if other subsidies see some sort of quid pro quo reduction. Yes, I am looking at the Malaysian fuel subsidy. Essentially, the fuel subsidy reduction would finance the new drug subsidy, making this system neutral.

Whether or not we subsidize the drugs in the end, I do think this arrangement could solve the dilemma.

One major problem with this model is the possibility of the sellers colluding with each other to jack the price up. Nevertheless, such problem is not unique to or the exclusive weakness of this system. Therefore, I do not think it deserves to be addressed here. A discussion on collusion would take away the focus of this entry.

Another way to approach the problem is by having the government purchases the drugs in huge quantity, get bulk discount and resell the drugs at cost, possibly, exactly like the Australian model. Or, on top of that, with subsidy, with method explained earlier.

I am unsure which method would provide cheaper drugs but the latter certainly have less red tape to worry about.