Subsidies suppress competition, interfere in fair market

LAHORE: Wastage of resources through subsidies or collusive bidding undermine the competitive process. It interferes with market signals and in case of subsidies on inputs leads to inefficient allocations, as perceived prices deviate from cost base prices.

We should take cue from developed economies that have since long realised that subsidies distort markets and have given powers to watchdogs. In fact, in the European Union subsidies that distort competition are prohibited unless targeted at stated objectives of EU and cause minimum trade and competition distortion.

The EU Competition Commission has the powers to order the recovery of illegal and incompatible subsidies. Creditable research has shown that limitation of wasteful subsidies attract foreign direct investment. This is the reason that only those Eastern European countries benefited from FDI that eliminated subsidies.

Subsidies or state aid is a preferential public assistance or a financial support given by a government to a certain business or economic sector in the shape of grants, interest and tax reliefs, guarantees, provision of goods and services at preferential terms, or waiver of license fee etc.

State aid gives the aid recipient an economic advantage that it would not otherwise have enjoyed under ‘normal market conditions’. It thereby confers an advantage to the aid recipient on a selective basis, which may distort competition in the relevant market.

In Pakistan, state aid is directed towards state-owned enterprises. However, experience has proved that the government support gives the SOEs little incentive to change.

Common argument in sustaining inefficient SOEs is saving “employment of large number of employees”. However the state should differentiate between “employments” versus “welfare”.

Moreover, often SOEs give employment as a favour and not on merit. Apart from power sector the other three main recipients of state aid in Pakistan are Pakistan International Airline, Railways and Pakistan Steel Mills.

State aid should be provided in case of natural disasters, as was done in wake of 2005 earthquake or during severe floods. Prudent state intervention is also essential to prevent market failures like the support given to the banks by developed economies to avert global financial meltdown.

As far as public procurement is concerned, the planners must realise that it accounts for 20-25 percent of Pakistan’s GDP. This is the reason that collusive bidding in public procurement is highly attractive for the contractors that keep bids very high thereby depriving the exchequer of billions of rupees annually.

Transparency International in one of its reports stated that the country could save up to $8 billion out of $50-60 million contract bidding if the globally accepted procurement rules were applied in letter and spirit.

This money is pilfered through anti-competitive practices in the form of collusive bidding/bid rigging that can take many forms. Some of the broad categories, which are not mutually exclusive, include cover bidding where one or more bidders submit bids that are highly unlikely to be accepted, to give an impression of competition bidding.

Or they indulge in bid suppression where one or more competitors who normally bid do not submit their bids so that a particular competitor’s submission is accepted. Major players in high value contracts collide to agree to do rotation where competitors take turns in submitting the lowest bid for similar projects.

In addition, some big players agree to restrict to specific market where the others agree not to enter. This is known as market allocation under which competitors divide up markets geographically or sector wise and agree not to compete in each other’s portion.

Another way to eliminate competition from the bidding process is to ensure the competitors a share in the contract through subcontracting. Under this arrangement, the competitors agree that those who submit a higher bid or do not bid will be sub-contracted on the project by the winner.

Public procurement consumes a large portion of national budgets and is therefore a lucrative market (According to World Bank 15-20 percent of GDP for most developing countries); collusive bidding agreements can be very difficult to detect as they are negotiated in secret.

Some inside information or search and inspection is usually required to establish such conspiracies. Fair public procurement practices have been established in most of the developed economies, but in most of the developing countries, the public procurement practices are similar to that of Pakistan.