Saturday, May 18, 2024

Is monopoly pricing by India’s ‘Big 5’ stoking inflation?

Former Reserve Bank of India deputy governor Viral Acharya has set the cat among the pigeons, arguing that the five biggest private business groups in India are contributing to persistently high core inflation. Their dominance in the economy is indicated in several ways that he details in a research paper published by Brookings Institution. The five groups have amassed assets, doubling their share of non-financial assets in the country over the past 30 years. They also doubled their share of merger and acquisition deals since 2011, even as the aggregate number of deals declined. Their economic expansion is manifest both in their breadth and depth of presence in the economy. The former is captured by the fact that firms belonging to these groups now operate in half of all industries, as per National Industrial Classification codes. The latter is captured by increasing market and profit share, especially since 2015. Their rise also coincides with a relative decline in the respective shares of the next big five (i.e., the Big 6 to 10).

According to a report by wealth management firm Marcellus, the top 20 profit generators earn a staggering 80% of the nation’s profits. This is twice the share a decade ago, reflecting increasing concentration of profits. The same is true of wealth creation. About 80% of the decadal increase in stock-market wealth measured as the value of the Nifty index was captured by just 20 companies. There is similar polarization in the free cash flow generation at companies, where the top dozen-and-a-half account for the major share. If we triangulate data in the Marcellus report with Acharya’s paper, it becomes clear that market power is getting concentrated. That in turn leads to pricing power. This is at the heart of Acharya’s thesis. In the standard lexicon of financial analysts, this is called the ‘pricing power’ of firms, which usually comes in a rising business cycle. When incomes and demand are rising, firms respond by raising prices. This is basic economics.

But elementary economics also tells us that the ability to sell at a mark-up over marginal costs, and the power to sustain monopolistic prices does not depend only on the status of the business cycle. It is not only under conditions of excess demand that firms enjoy pricing power. It could be on account of a basic feature of the existing market structure. High prices can be sustained in monopolistic markets even if demand slackens. The aggregate ‘consumer surplus’ is appropriated much more by the supply side. Under perfect competition, there is no surplus left to appropriate, since prices go down to marginal costs.

Fair competition is also nurtured by a vigilant watchdog—the Competition Commission of India. Our competition law penalizes abuse of dominance. It replaced the older Monopolistic and Restrictive Trade Practices Act; even the tech giant Google has not been spared a penalty for abusing its dominance in the Android market. The competition law framework is more concerned about anti-competitive behaviour and less about monopolies per se. This thinking goes back to economist Joseph Schumpeter, who said that a competitive process is one where every entrepreneur wants to be a monopolist, at least temporarily.

Sooner or later, the monopoly gets contested as rivals enter by either under-pricing it or innovating. The reign of the monopolist is short-lived, thanks to the phenomenon of ‘creative destruction’. Schumpeter described it as a “process of industrial mutation that incessantly revolutionizes the economic structure from within”, destroying the old one and creating a new one.

Does India’s experience with today’s Big 5 concentration, as hypothesized by Acharya, corroborate Schumpeter’s thesis or contradict it? If the playing field is not level or entry barriers are stiff, then creative destruction will not happen and incumbents will get bigger. Acharya warns that the Big 5 may become too big to fail, and receive largesse and rescue even if over-leveraged.

Bigness can also manifest in other ways. What if a big firm with deep pockets is able to resort to predatory pricing and can block off new entrants? It was evident in the telecom sector, where there was zero-pricing for long that did not attract the Competition Commission’s ire. What if a few big firms enjoy duty protection from imports? We have seen this too as part of the strategy to promote ‘Make In India’ or as part of the production-linked incentive scheme. Such protection is also part of an implicit attempt by the Indian government to develop global champions based in India, much like what was done in Japan and South Korea in the last century. Are we trying to mimic the history of keiretsu and chaebols which led to the creation of firms like Mitsubishi, Sumitomo and Samsung? It worked in a different context about half a century ago, but is not workable in the globalized world of today.

Acharya’s thesis is persuasive and needs careful examination. Formalization of the economy, a wider goods and services tax net, demonetization and fiscal pump-priming during the pandemic have helped larger firms disproportionately, while smaller firms suffered. But inflation has also been driven by repeated hikes in the prices of food items such as milk, eggs and pulses, and commodities like oil and energy. Not all of this can be attributed to a monopolistic market structure enjoyed by the Big 5. Further, even with high tariffs, we cannot ignore the competitive pressure of imports on big firms in India. Nevertheless, Acharya’s paper is a good trigger for the Competition Commission to initiate broad-based research on the inflationary impact of the market structure in India.

Ajit Ranade is a Pune-based economist

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