How to go about auctioning public assets

13 Nov 2019

Focussing on short-term revenue maximisation can hurt long-term welfare. Auctions must be redesigned to meet a wider set of goals.

Since the last decade the auction of key public goods has emerged as yet another important tool in India for resource mobilisation. As a result the auction mechanisms are increasingly being designed to maximise revenue. However designing these auctions with the single-minded focus of appropriating more and more revenue for the government may be imposing long-term costs on other sectors of the economy.

For example bids in mineral auctions — which require revenue from minerals to be shared with the government — have ranged from 2 per cent to more than 200 per cent with 14 winning bids of more than 100 per cent suggesting that the winners were willing to part with more than the prescribed value of the resource.

Such high costs are justified only when certain malpractices such as hoarding or outbidding competitors are in play leading to an oligopolistic market structure creating artificial scarcity etc. This could also strangle the more productive downstream industries such as metal and metal products which have much higher employment and output multipliers than the mineral industry.

Hence while mineral auctions could be considered successful in the short run due to high revenue generation the loss of jobs and the fall in production levels in the long term may more than offset such gains. Similar concerns have been highlighted by TERI which states that auctions in minerals “have the potential to reduce the financial viability of metal making industry and reduces competitiveness”.

Economic trade-off

This trade-off between short-term revenue maximisation for the seller and long-term efficiency in the overall economy has been duly noted under the study of auctions in economics. Indeed this conflict exists in all sectors where the resource being auctioned acts as a productive input for other spheres of the economy as well. A simple hypothetical example provides insight.

Let’s imagine the government auctions to contending firms the private ownership of a public good (say highways) which serves as an input for all the competing firms. Auctioning a higher fraction of the public resource may lead to greater revenue realisation for the government; but at the same time it will also lead to the privatisation of a larger part of the previously free public resource which will result in an increase in the said firms’ cost of production.

This in turn would reduce firms’ production and increase the market price leading to a dampening effect elsewhere in the economy. Hence simply auctioning a higher proportion of the public good to gain more revenue may prove costly in the long run. Land auctions are yet another example where such a trade-off may be most likely.

Different approaches

Alternate auction mechanisms rather than revenue maximising ones may be required to balance the short-term financing need of the government with the overall economic benefit. The Vickerey-Clarkes-Groves auction mechanism is one such method where theoretically the winning bidder has to make transfers to all other bidders to offset their losses.

Putting theory to practice however may need more nuance. One way would be to employ end-user agreements. For example in the case of mining auctions this would appear as bidders ensuring some supply to domestic players. Such end-user agreements are common in land auctions where a parcel of the land is required to be devoted to low-income housing. Another way might be to practice ‘asset recycling’ which involves commitment from the government to allocate the revenue received from the sale/lease of pre-existing assets into some welfare-generating projects with the view to offset efficiency losses to other stakeholders.

Australia has proved to be successful in the implementation of this practice. For example recently three new highways of 49.8 km costing A$160 million have been funded by Infrastructure NSW an independent body created by the state of New South Wales through its asset recycling programme. Moreover a five-year National Partnership Agreement on Asset Recycling in Australia mentions increased economic activity and employment as the desirable outcomes to achieve the objectives of enhancing growth and productivity through sale/lease of existing public assets.

This idea is gaining traction in India as well. For instance the NHAI plans to generate more than ₹85000 crore through asset recycling to finance its road construction work. However the efficacy of asset recycling would essentially depend upon the government’s capacity to invest the proceeds into its most productive unit with the view to maximise public value.

India must also learn from international experience where auctions have been used to usher higher technological standards rather than simply creating wealth for the government. This can be introduced through a more stringent bid qualification requirement for participation in auctions.

Designing the mechanism

In sum the present approach of short-term revenue maximisation from auctions can hamper long-term welfare growth. The need of the hour is a strategic approach that incorporates context-specific application of mechanism design tools for designing auctions that lead to holistic gains. To achieve these multi-dimensional goals policymakers obviously need to take the help of specialists in designing the auction procedure. It is ironic that not just academics noted this problem long ago; economists observed it too and have devised mechanisms to overcome the issues. Yet specialists/ mechanism design experts have never been involved in auction procedures.

The non-professional approach in India is best explained by the fact that revenue generation from auctions is typically 3-4 times government’s expected revenue. It would appear that policymakers have very little idea of the subject they are dealing with so surely this is where auction specialists need to step in for the greater public good.

Madhura Dasgupta and Samarth Gupta are Associate Fellows and Sanjib Pohit is Professor at NCAER. Views are personal

Published in:  Business Line, November 13, 2019