22 March 2012

The myth of the CAG's 2G and coal 'scam' numbers

It's been quite a change. The cold, dark, dreary London mornings have been replaced by hot, humid Mumbai ones. I haven't seen a cloud in a month and a half. Me alone in my lovely Mornington Crescent flat has given way to five mad people in a two bedroom overlooking the mangrove forest in Versova. My cycle has given way to the 11 year old family car (some of the time that is, as and when I can wrestle it from the other two claimants). My old Dell - the one that was on life support - has made way for a swanky new Samsung laptop. Which in turn means Linix has given way to Windows. Oh, and my acting dreams have given way to harsh reality.

But anyhow, the CAG, in a draft report, has apparently said that the government caused a loss of 10.67 lakh crore (106700000000) rupees to the exchequer by allotting and not auctioning off coal blocks between 2004 and 2009. Apparently, this was calculated by valuing the quantum of coal in these blocks at the market price.

Also, they tabled a report estimating a 1.76 lakh crore presumptive loss in the 2G 'Scam', where you get the picture if you replace coal blocks with blocks of 2G spectrum.

Plain, simple logic will tell you that these figures are absolute rubbish.

The key insight is that coal and spectrum, both are natural resources that are inputs into one or several production processes.  Spectrum is used to provide mobile telephony services, and coal is used as an input in the power, steel, cement and other heavy industries.

In a situation where the final product is sold in a competitive market, like in mobile phone connections in India, competition applies pressure on margins. Pricing is largely driven by costs, as no player can set arbitrarily high prices as no one has monopoly power. In fact, in a competitive setting, cutting prices means gaining a large market share, so players tend to cut prices till they are making only a very small margin over their costs.

In such a setting, what happens if you increase the price of one of the inputs? You increase costs. And since prices are largely cost driven, the price would increase. So yes, if the government had auctioned 2G spectrum, it would have maybe got an extra 1.76 lakh crore rupees from the bidders, but the bidders would have recovered most of this from the end consumers. The loss to the exchequer of the 2G 'Scam' was nowhere close to 1.76 lakh crores, as this doesn't take into account the increase in mobile telephony prices that would have accompanied an auction.

The coal case follows pretty much the same logic for industries where the final product is sold in a competitive setting. Of course, a lot of coal goes into power generation, and power supply in many places is a monopoly. However, these are state monopolies, and the electricity prices are regulated by the government. Here again, there is no scope for arbitrarily high prices for the final product (electricity) due to regulation. Given that the government has set a price, a higher cost (which would have resulted if coal blocks were auctioned) would mean losses, and since these are government companies, most of the money gained from the auction would have to be spent subsidizing electricity companies in distress. Again, the loss to the exchequer is nowhere near 10.67 lakh crores as this calculation fails to take into account a full picture of the world in which natural resources were auctioned rather than allocated.

And what's worse, by putting such poorly thought figures out in the public domain (the coal 'scam' figure was leaked - the report is not public) the CAG gives the opposition an excuse to stall parliament, causing teh exchequer to lose whatever money is spent on running parliament. This equates to 2 crore a day (http://www.dnaindia.com/india/report_parliament-disruption-costs-exchequer-rs2-crore-a-day_1616166). What cannot be measured is the value of all the policies that might have been discussed and framed if parliament did not resemble a circus.

Further, imagine the cost to the nation if the public actually buys these figures and replaces this government with another, more inept one...

All this is not to say that I support whatever has happened. I think natural resources should be auctioned, not allocated, and mechanisms should be put in place to subsidize some of these resources where the final product is in the public benefit. That is just a more efficient way of doing things. And it is a fact that successive governments throughout our history have allocated, not auctioned.

However, I am sick to death of people drumming on about the extent of corruption citing wholly inaccurate figures like the CAG's. There is a proper, well established way to calculate figures like these, and it's called counterfactual analysis. Set up a counterfactual, taking into account everything that would have happened under the alternative policy, and derive prices, output and costs. Then compare them to the actual, realized prices, output and costs. It happens all the time in every developed country. Incidentally, my company gets paid to do studies like this all the time.

Please stop talking, and start thinking.

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