Policy-making is a highly complex process in which the Government is obliged to play the role of a neutral arbiter as it strives to harmonise the often widely differing interests of economic agents in the country. Experience suggests that even with the best intentions, outcomes that emerge from such a process are never 'perfect' and some agents affected by these decisions will be dissatisfied by them.
Welfare economics explains that problems arise because people disagree on particular policies as their individual, or collective utility preferences are different. At a fundamental level, for instance, investors want to maximise profits, employees want to maximise wages and the general public wants low prices and maximum choice. Such utility preferences, if pursued beyond an acceptable level, are a recipe for disagreement, if not of outright social conflict.
It should be noted that policy analysis alone, however rigorous, cannot resolve such disagreements; it can merely clarify the differential impact of particular policies on different interest groups. In a democratic society, the decisions of the state itself, or any of its institutions with specific mandates, are deemed to have legitimacy as they are assumed to be in the overall public interest.
However, different interest groups, such as individual trade associations, who are affected by the policies of the state, often seek implausibly to dress up their own narrow interests as being those of the wider public and to advance their particular interests on that basis.
It is therefore understandable that recent decisions of the Competition Commission of Pakistan (CCP) have been subjected to criticism by the cement industry, or individuals acting on its behalf, largely as if their interests coincided with the general public interest.
The specific burden of these criticisms is a) that the cement industry has been needlessly singled out by the CCP when the economy has been suffering from shortages and high prices of atta, sugar, electricity, petroleum and other daily necessities and that there had, in fact, been no public complaint about high cement prices; b) that the CCP has alleged that there is a cartel in the cement sector whose job is to maximise profits, whereas the industry has sustained a collective loss in 2007/08 and cement prices have risen at less than the rate of both the wholesale and consumer price indices; and c) that the penalties imposed on the cement companies by the CCP have been excessive and have caused a decline in the share prices of cement companies adversely affecting not only small shareholders but new investment in the country.
These are grave charges that need to be examined dispassionately. It might be worthwhile to point out that there is, incidentally, an entire body of literature in economics that discusses the use of fines imposed on companies to enforce competition law prohibitions.
The literature shows that promoting competition and imposing penalties for violating company law have become the norm not only in developed countries, but increasingly in developing countries where the private sector is the main engine of growth. In this respect, Pakistan, far from being an outlier, has become part of the mainstream in having a modern and state of the art competition regime and in seeking to enforce its compliance through the CCP.
Deterrence is an important part of law enforcement. The maxims of welfare economics, which deal with promoting the public interest also deal, in the context of competition law enforcement, with how deterrence can be achieved, the trade-off between fines/penalties and the likelihood of detection and punishment and rewarding co-operation and efforts at compliance.
Briefly put, welfare economics projects the view that deterrence works only if the expected fine exceeds the expected gain from the violation of the law. Furthermore, deterrence requires that, given the significant economic costs incurred in imposing penalties (legal, administrative and lost management time) there is a case for levying relatively high fines/penalties infrequently, rather than relatively low fines/penalties frequently.
At the same time, welfare economics also indicates that because of the economic and social costs of relatively high penalties there might be an equally valid case, in certain situations, for limiting penalties for initial offences and also on the grounds of proportional justice. In addition, deterrence might be better achieved if one or more of the companies alleged to be implicated in the violation co-operated with the relevant investigation.
What this points to in general terms is that levying penalties in a careful and judicious manner, is a standard tool in the hands of all competition authorities to enforce competition law. Indeed, all competition authorities have to balance the objective of deterrence through penalties against the disincentive effects of such penalties.
The CCP's action in penalising the cement companies is undoubtedly novel in the context of Pakistan, but given that there is a new law to govern and promote competition in the country, there has perforce to be a meaningful opening salvo in its enforcement in the face of clearly egregious conduct; otherwise, Pakistan's Competition Ordinance is likely to become an academic curiosity in the country.
Laws are meant to be enforced and not left as powers in reserve, if they are to serve their intended purpose. The cement industry has not been singled out. CCP has explained that it is actively looking into other sectors of the economy where suspicions of cartelization exist.
Against this background, the central questions that need to be answered from a layman's perspective are: i) whether the CCP is justified in alleging that a cartel really exists in the cement industry and ii) if it is justified, whether the penalties it has imposed are fair. As far as (i) is concerned the definition of a cartel is one in which a group of companies agrees to fix prices or divide markets in a collusive manner.
Whether prices in the cartelized industry rise faster or slower than overall prices in the country is, in itself, not immediately relevant; the relevant factor is that there was strong evidence in the eyes of the CCP that companies had colluded in fixing prices and setting quotas over many years, actions that have negated the free play of markets in price determination.
Further, a cartel may not be directly instrumental in damaging the public interest in a demonstrably visible manner; indeed, in an inflationary environment, it is often convenient to camouflage the factors affecting prices in one sector within the range of factors affecting the overall level of prices. It is the phenomenon of collusion that is a violation of competition law, not the behaviour of prices alone; these can rise for many reasons.
Likewise, lower profits in any one year, in this case 2007/08, are by no means conclusive proof that there was no cartel operating in the cement sector in that and/or preceding years. Profits can, and do, vary from year to year and it would be remarkable indeed if a large number of cement companies would have continued to exist in the sector for several years without making profits.
The bottom line is that there has been no exit from the cement industry for several years and no reallocation of resources to more efficient uses - this in itself is an indication of cartelization protecting, as it always does, the inefficient.
As far as (ii) is concerned there is plainly no objective standard whereby a fine or penalty can be deemed to be 'fair' in the eyes of everyone involved. For a law enforcing agency like the CCP, the penalty, as a deterrent, is obviously fair in that, while substantial, it falls well short of the maximum (15 per cent of turnover) it could have imposed.
It is in the form of a percentage and thus treats big and small companies on a comparable basis. Moreover, the principles on which the penalty is based have been enshrined in the Ordinance and cannot be construed to be arbitrary. For the cement companies any penalty would indeed be unfair as, in their eyes, they have done nothing wrong.
On the contrary, the general public has argued that a higher penalty might well have had a much stronger deterrent effect, not only for the cement companies, but also for any other set of companies operating as cartels in any other sector of the economy.
As it happens, while the penalty of around Rs 6 billion may appear large in absolute terms, spread over last year's output of 20 companies it amounts, in most instances, to no more than Rs 10-11 per bag; this at a time when cement prices are around Rs 250 per bag. At this level, the penalty is hardly draconian, more like a rap across the knuckles.
To argue that a penalty of this size is likely to adversely affect shareholder confidence and the general investment climate in the country is to carry exaggeration to the point of absurdity. Incidentally, the fines in Europe and the US for cartelization are proportionately much higher, in addition to disqualifying the directors of the companies participating in the cartel.
Indeed, compliance with the law by paying the penalty might well have a positive impact on shareholder confidence, as tends to happen in the developed countries where share prices often go up after fines have been imposed for company law transgressions. Finally, there is the question why promoting competition is important.
Both theory and empirical evidence have proved beyond reasonable doubt that competition improves individual company performance and, thus, the overall economic performance of a country. Pakistan should be no exception, except in the eyes of its mollycoddled businessmen. In fact, it might well be the case that Pakistan has paid a heavy price in not having had a proper competition policy regime until 2007 and allowing anti-competition behaviour to thrive unchecked. Over the past two decades, there has been growth in the economy but without much structural change in most sectors.
By lack of structural change is meant that efficient and inefficient producers continue to co-exist in many sectors. It has to be remembered that competition involves the growth and decline of firms, the entry of new companies and the demise of poor performers.
The evidence across the world points to the fact that competition works by creating incentives for companies to perform better, by demarcating between more and less successful companies in particular sectors. The latter set of companies need to invest resources and effort in 'catching-up', while cartels, on the other hand, clearly ossify the process.
Competition is needed to magnify the positive impact of new entrants, who affect aggregate performance, both by virtue of the new capacity that they create and by influencing incumbents with their energy and innovation. Competition is needed also to facilitate the exit effect whereby poor performers are enabled to leave the market and release resources. The CCP by promoting competition is playing a vital role in making Pakistan a more competitive economy. Its efforts should be lauded, not decried.
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