Auctions for Public Resources

by

NITIN DESAI

Auctions for public resources must be designed to serve the common good and not just to maximise public revenues.

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Auction theory has attracted a great deal of attention from economists since William Vickrey, who got the Economics Nobel in 1996, wrote his pioneering article on the subject in 1961. Last week the 2020 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (popularly known as Nobel Prize for Economics) was awarded to Paul R. Milgrom and, his Ph.D supervisor at Stanford, Robert B. Wilson. They have made many contributions to auction theory; but they are best known for designing an innovation in auction methods for the Federal Communication Commission in USA called the Simultaneous Multiple Round Auction (SMRA).

Open auctions have two modes-an ascending mode in which the auction ends when all but one bidder drop out and the winner pays only what he bids to top the second highest bidder and not what the item is worth to him and a descending mode where the auctioneer starts with a price and reduces it till he receives the first acceptance, so that the winner pays what the item is worth to him. Sealed bid auctions also have two modes where the highest bidder wins at the price he quoted or at the second highest price.  The second highest price option in sealed bids encourages the bidder to bid what the item is worth to him as he does not have to pay that but only what the item is worth to the second highest bidder. This result is similar to the open ascending auction.

The SMRA modality departs from this in several significant ways. First it puts a whole set of interdependent items like geographically distributed telecom spectrum for simultaneous bidding by eligible bidders. Second, the bidding takes place over several rounds, with the auctioneer making known the bids to all participants. The process continues till there are no new bids for any item on offer. Third, the bidding is not closed item by item but remains open on all items till the end. Fourth, to prevent bidders from using a wait and watch strategy, to remain eligible they must  put in new bids or hold the high bid on an item on which new bids have stopped coming. When interdependent items are on offer this means that someone who is losing out on an item he prefers can step in and get another one by putting in a new bid for an item where the bids were static.  So someone who wants Maharashtra and Mumbai region spectrums on offer, but is losing out in Mumbai can seek compensation by bidding for the Gujarat region spectrum There are later variants that make linkages easier by allowing bidding for combinations of items.

The first use of this SMRA method in India was in the 3G auction in 2010 when 3-4 generic licenses in 22 Telecom circles were put up for simultaneous auction that stretched over 34 days and 183 rounds and generated Rs 670 billion of revenue for the Government. All the items on offer were sold at above the reserve price.  However the subsequent five SMRA auctions for telecom spectrum  from 2012-2016 were less successful.  Moreover there is a widespread belief that the high prices paid by the telecom companies has compromised their viability.

Sealed bid auctions for resources are more common. Auctions for oil exploration have been conducted in India with blocks being awarded to companies offering a maximum share of oil and gas to the government initially and, more recently, blocks in little or unexplored basins being awarded to companies offering to do maximum exploration programme. The impact on public revenue will depend on the actual implementation of the exploration licence.  A first sealed bid auction was held recently for commercial coal blocks on the basis of revenue sharing  for 38 coal mines, of which 15 did not receive any bids.  Here too, the impact on public revenue will depend on implementation.

Are auctions, that maximise the returns to public revenue the best way of allocating publicly owned resources to private users? There is an impression, after the Supreme Court's judgement in the 2G and coal mining licences case that open auctions are the only legally approved route. However, on a reference made to it in 2012, the Supreme Court  clarified:“Auctions may be the best way of maximizing revenue but revenue maximization may not always be the best way to subserve public good. "Common good" is the sole guiding factor and a norm under Art. 39(b) for distribution of natural resources. It is the touchstone of testing whether any policy subserves the "common good" and if it does, irrespective of the means adopted, it is clearly in accordance with the principle enshrined in Art. 39(b).” It went on to say that “mandatory auction may be contrary to economic logic as well. Different resources may require different treatment.” But any alternative method  “has to be fair, reasonable, non- discriminatory, transparent, non-capricious, unbiased, without favouritism or nepotism, in pursuit of promotion of healthy competition and equitable treatment.”

It is possible that in certain cases like, say the auction of treasury bills, the common good is best promoted by maximising the return to public revenues.  But alternatives need to be considered and have been used for instance in the recent oil exploration auctions.

The 2012 Supreme Court response to the reference from the Government means that any alternative to revenue maximising auction must be rules based and have no scope for discretionary decisions, so as to rule out corruption and crony capitalism. It has to be transparent, which an open auction process is and it must involve terms that are fair to the bidders and not unreasonably exploitative. Given this one can conceive of bidding being based on social ends? For instance the bidding for auction of urban land could be on the basis of offers of the number or area of low cost houses guaranteed by the bidder in return for getting the land at a fixed reserve price. The real challenge is to define a common good metric that is measurable and verifiable and relevant for the resource that is to be transferred to  private companies or individuals.

The auctioning of pubilcly held resources is welcome as it ensures transparency and reduces the scope for corruption.  But auctions must be designed to serve the common good, as required by the constitution, and have clear safeguards against collusion and manipulation.