Second-best policy frameworks

Mitigate corruption by designing policies focused on final outcomes

A crusading Controller and Auditor General and a wave of populist anger exemplified in civil society movements like those led by Anna Hazare and Arvind Kejriwal have provided a much needed jolt to India’s ruling establishment. The litany of scams over the past two years involving public resource allocations and government procurements has exposed the unholy nexus that characterises business-government relationships in India.

It has provided an excellent opportunity for introspection and to enact measures that could minimise such egregious robber-baron capitalism. However, much of the righteous indignation has been channeled into punishing those responsible and the establishment of ‘strong’ regulatory institutions that can apparently control such corruption. Unfortunately, such simplified populist solutions, while intuitively attractive, have had the effect of “crowding-out” more serious analysis of the underlying malaise. Further, the window of opportunity to conduct a serious examination of the systemic incentive distortions that have fuelled such corruption appears to be closing.

We need to realise that corruption cannot be seen in isolation from the dynamics of the complex processes of India’s democracy and the deeply entrenched relationship between politicians, officials, and businessmen. Populist revolutions that peddle the hope of immediately eliminating these relationships and ushering in an era of corruption-free governance are most certain to remain illusory. In the circumstances, any solution that stands a chance of making significant headway has to acknowledge this reality and therefore the need to work within the prevailing paradigm and change the incentives that fuel such corrupt practices. In particular, we need to design policies that go beyond “stage one” (of allotments) and focus on the achievement of the final outcomes.

Photo: Katie Dalton

Let me illustrate this with three examples – telecom spectrum allocations, coal block allotments, and third party quality control in engineering works. Amidst the acrimony surrounding the telecom spectrum license allocation, it needs to be borne in mind that we have arguably the most competitive telecommunications market in the world.

In an excellent (yet to be published) working paper, Professor Sandip Sukhtankar of Dartmouth College has used empirical evidence to document the effect of the discretionary spectrum license allocations on India’s wireless telecommunication market. Controlling for various factors, he finds that the corrupt allocation of licenses had no impact on the number of subscribers, prices, usage, revenues, or measures of quality. What contributed to producing such efficient final outcomes, despite the massive established corruption?

There is enough evidence that elements of the telecoms policy, by design or otherwise, mandated multiple operators in each telecom circle and nationwide licenses for a few firms, provided the right competitive environment. As Sandip writes, the “resale of licenses to competent firms combined with fierce competition in the telecom sector may have mitigated the potential deleterious impact of corruption”. This forced all operators, including the larger incumbents and those new entrants who acquired licenses illegally, to pass on a substantial portion of their windfall gains (from preferential allocation) to their consumers. The wireless telecoms market expanded spectacularly on the back of the lowest tariffs anywhere in the world. In fact, it would be interesting to quantify the welfare gains to consumers, by way of the rapid proliferation of new telecoms technologies and ultra-low tariffs, and compare it with the estimated loss to the public exchequer.

Contrast this with the discretionary concessional coal block allotments to power generators. A downstream policy framework that would have fostered competition and outcome focus and forced allottees to pass on to consumers some of the gains from acquiring coal blocks at concessional prices was missing. It is a damning indictment of the allotment policy framework that barring a handful, most of the allottees kept their blocks undeveloped in the expectation of selling out at the right price as an acute coal shortage gripped the country.

Here too, a preview of the possibilities comes from the bids received for two Ultra Mega Power Plants (UMPPs). The successful bidders, who too were allotted coal blocks, offered highly competitive levellised tariffs – Rs 1.19 and Rs 1.77 per unit of electricity for the Sasan and Tilaiya UMPPs respectively. The prevailing tariffs for similar plants are more than Rs 3 per unit. It is undeniable that these generators could not have offered the low tariffs if they had not been able to access fuel at discounted prices.

This raises the question of whether it may have been more effective if the allotment of coal blocks, even when done at concessional rates, was made conditional on its immediate development and the time-bound delivery of power at competitive prices to distribution utilities. There is nothing to suggest that it would not have resulted in beneficial social outcomes similar to the telecommunications sector, both in terms of generation capacity addition and lowering of tariffs.

My final example is a more generic one. It is about the practice of third party quality control inspections that have become commonplace in engineering works across departments in recent years. Despite all its implementation flaws, it has focused attention on the ultimate objective of ensuring quality in engineering works. In the past contractors merely had to win the contract to execute works with poor quality and make handsome profits. But third party inspections, when effectively implemented, are a strong deterrent against such easy profiteering.

The objective here is not to condone corruption. For sure, all those responsible should be punished and a strong deterrent message communicated and procurement processes made more transparent. However, it is only realistic that, given the stakes involved, public procurements and resource allotments cannot be completely insulated from political considerations.

Therefore, we need to acknowledge the relevance of “second best” policies that assume the inevitability of rent-seeking, in varying forms and degrees, in procurement and allocation decisions and try to mitigate them. The three aforementioned examples illustrate how outcomes-focused secondary policy frameworks that go beyond the vitiated initial allotment processes can help align incentives and increase the likelihood of achieving the desired policy objectives. The war against corruption will have to be fought at multiple dimensions, and such policy frameworks are critical to the final success.