{"id":695,"date":"2013-10-31T17:11:00","date_gmt":"2013-10-31T17:11:00","guid":{"rendered":"https:\/\/blogs.isb.edu\/bhartiinstitute\/?p=695"},"modified":"2025-12-31T09:32:39","modified_gmt":"2025-12-31T09:32:39","slug":"coal-block-allotment-getting-the-auctions-right","status":"publish","type":"post","link":"https:\/\/blogs.isb.edu\/bhartiinstitute\/2013\/10\/31\/coal-block-allotment-getting-the-auctions-right\/","title":{"rendered":"Coal block allotment: Getting the auctions right"},"content":{"rendered":"\n

By Rajesh Chakrabarti, Executive Director, Bharti Institute of Public Policy, ISB<\/strong><\/em><\/p>\n\n\n\n

This article<\/a> was first published in the Economic Times on Oct 31, 2013<\/em><\/p>\n\n\n\n

The current controversy over the coal block allotment is perhaps the latest and one of the most sordid examples of inefficient allocation of national resources, but the malaise is hardly new.<\/p>\n\n\n\n

In fact, in an interview back in 2010, Raghuram Rajan had identified favoured allocation of resources as the driving force behind the fortunes of many billionaires in India \u2013 a nation that ranked second only to Russia in terms of the number of billionaires per trillion dollar of GDP.<\/p>\n\n\n\n

How then to best allocate national resources \u2013 mining rights and telecommunication spectrum \u2013 in an efficient manner? Auctions come to mind immediately as competitive and transparent mechanisms of allocating resources. They allocate resources to the highest valuer, ensuring both socially most productive allocation as well as maximum revenue gathering by the exchequer.<\/p>\n\n\n\n

Still a Surprise Element<\/strong><\/p>\n\n\n\n

But governments around the world have long used auctions to allocate resources and yet the mechanism has at times thrown nasty surprises. Auctions can be of several types and the success of the mechanism depends critically on its design.<\/p>\n\n\n\n

Take, for instance, the 3G spectrum auction in six European countries in 2000. While in UK and Germany, the auction yielded prices over 600 per person, in Switzerland, the yield came to only 20, about 5% of the predicted value. In 1999, in Germany, as spectrum was being auctioned in 10 blocks, Mannesman and T-Mobile colluded to split the spectrum between themselves, each picking up half the offering at a very low price.<\/p>\n\n\n\n

A successful allocation mechanism should ensure widespread participation, a prerequisite for competition. It should also prevent collusion so that each bidder reveals close to its true reserve price for the item or items being auctioned.<\/p>\n\n\n\n

Sealed with a Dutch<\/strong><\/p>\n\n\n\n

Broadly, auctions follow two formats: ascending, or \u201cAnglo\u201d, approach where an auctioneer keeps raising prices till there is only one bidder left (there is a descending version as well); and sealed-bid, or \u201cDutch\u201d, auction where bids are simultaneously revealed. The former has the advantage of transparency, price discovery and revenue maximisation, but, in the presence of one or more \u201cstrong\u201d players, may end up discouraging participation by smaller players, in the absence of which the supposed \u201cstronger\u201d player can get away with offering significantly less than what it truly values the resource at.<\/p>\n\n\n\n

A mix of the two, \u201cAnglo-Dutch\u201d, is sometimes resorted to that runs the \u201cAnglo\u201d way till only two bidders are left in the fray, and then switches to \u201cDutch\u201d with the floor of the last price of the Anglo auction.<\/p>\n\n\n\n

Another deterrence for auctions is the infamous \u201cwinner\u2019s curse\u201d, referring to the fact that the actual winner is likely to be the party that has overvalued the resource the most. The issue is particularly significant when the resource being auctioned, like mining rights, whether land or offshore, is difficult to value. This is where valuation becomes critical.<\/p>\n\n\n\n

\u201cCommon-value\u201d resources like oil, that are valued pretty much the same way per unit by all parties, but whose supply per block is something each bidder is uncertain about, differ from \u201cprivate-value\u201d items to which bidders assign different values irrespective of the valuation given by others. The \u201cwinner\u2019s curse\u201d problem is strongest in the former.<\/p>\n\n\n\n

Tailor-Made for Scam<\/strong><\/p>\n\n\n\n

A standard solution to this problem is the \u201csecond-price\u201d option where the highest bidder gets the resource but pays the next highest bidder\u2019s bid. A common result: less hesitation to bid on the higher side. But even this can throw uncomfortable surprises. Consider the embarrassment of the New Zealand auctioneer \u2013 and the immediate suspicion of foul play had it been in a country like India \u2013 when a winner bidding NZ$7 million walked away paying the next highest price of NZ$5,000! Clearly, the presence of a reserve price is essential to avoid such situations.<\/p>\n\n\n\n

While under certain, rather unrealistic assumptions, all major auction designs would yield the same results, in reality, the suitability of the design to the resource being auctioned, the nature of information about it and the nature of competition among bidders hold the key to the success of the auction process.<\/p>\n\n\n\n

Then, one has to pay attention to other auctions as well. Turkey auctioned two mobile telephone licences in 2000; sequentially, with the condition that the price of the second auction could not fall short of the first. The result? The winner of the first auction bid (and paid) a price so high that it could never be worth with two rivals in competition. The second licence, naturally, went unclaimed!<\/p>\n\n\n\n

Rules and punishments are not beyond question either. The design issues apply not just to minerals \u2013 coal or offshore oil, for instance \u2013 but also to PPP projects where we have often seen re-negotiations and cost escalations. Auctions are better than the first-come-first-served or government-determined allocation, but their outcomes depend critically on the appropriateness of their design.<\/p>\n\n\n\n

DISCLAIMER<\/strong> : Any comments, speeches, articles, blogs, podcasts, videos\/vlogs, opposite the editorial page\/opinions andeditorials page (OP-ED), interview response etc. made by individuals should be accompanied by a clear disclaimer from the ones given below.<\/p>\n\n\n\n

\u201cThe views expressed in this article are personal. Prof Rajesh Chakrabarti is a faculty at the Indian School of Business.\u201d<\/p>\n","protected":false},"excerpt":{"rendered":"

By Rajesh Chakrabarti, Executive Director, Bharti Institute of Public Policy, ISB This article was first published in the Economic Times on Oct 31, 2013 The current controversy over the coal block allotment is perhaps the latest and one of the most sordid examples of inefficient allocation of national resources, but the malaise is hardly new. 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