Monopolies and markets

Published in The News on November 03, 2020

One frequently reads or hears about the need for the structural transformation of the economy by means of which the institutions or people advocating such reforms usually emphasise changes in macroeconomic policies. This includes widening the tax net, reducing the fiscal deficit, enhancing factor productivity etc.

However, very little attention is paid to a major structural distortion – the all too pervasive and baneful presence of monopoly and cartels in many sectors of Pakistan’s economy. This form of market control by one or a few firms acting in league with each other results in adverse consequences for consumers that takes the form of high prices and reduction of consumer choice.

We can review the financial statements of publicly listed companies to identify certain firms that have established a preeminent position in their respective sectors and highlight how market dominance boosts firms’ profitability albeit at the expense of the wider economy.

One example is a multinational that has a dominant position in Pakistan’s food sector. The average Return on Equity (ROE), a profitability metric which indicates the rate of return on funds invested by shareholders in this company, over the three-year period 2017-2019 was a staggeringly high 228.9 percent.

The Return on Assets (ROA) is another profitability measure that measures the rate of return on resources such as plant and equipment used by the business, regardless of whether the money spent to purchase these assets comes from shareholders or creditors. Here the ROA over the same timeframe was a very high 18.8 percent.

The ROE and ROA figures for the food company mentioned above are such that are unlikely to have parallels anywhere in a competitive market and are prima facie indications of monopoly power.

To clarify the influence of market dominance, the returns indicated above may be compared with the returns earned by the same company’s parent. The three-year average ROE and ROA for the parent’s global operations is a decidedly more modest 11.8 percent and 7.7 percent, respectively. Respectable enough for the Fast Moving Consumer Goods (FMCG) sector in the international context, but definitely not mouthwatering like the returns earned in Pakistan which is a veritable gold mine for this firm’s affiliate.

Turning to the three major automobile companies with foreign shareholdings that are listed on the Pakistan Stock Exchange, we find that during the three-year period 2017-2019 the average ROE and ROA for all three listed car companies was 33.0 percent and 13.2 percent, respectively.

For purposes of comparison, I examined the financials of five major publicly listed automobile companies (courtesy Reuters’ financial reports) that are household names around the world. These are BMW (Germany); Daimler (Germany); Ford (US); Tata (India); and Toyota (Japan).

The average three-year (2017-2019) ROE for these five companies ranged from negative 6.9 percent (Tata) to 12.7 percent (BMW). The three-year average ROA is lowest for Tata at a negative 1.5 percent and highest for Toyota at 3.7 percent.

The average three-year ROE and ROA for all five of these international automobile companies collectively is 7.9 percent and 2.0 percent, respectively, with both of these profitability metrics being significantly lower than the average 33.0 percent for ROE and 13.2 percent for ROA calculated for the three Pakistani car companies.

What are we to make of these ratios? International companies operate in markets with intense competition and their relatively low rates of return reflect this fact; on the other hand Pakistan’s automakers are shielded from such pressures.

Do firms operating in Pakistan face greater political and business risks and therefore deserve a higher rate of return? Not if the meaning of risk is variability of profits since these firms have less profit variability in a statistical sense than their counterparts abroad. (The recent drop in corporate profitability in Pakistan owing to Covid-19 is an across-the-board phenomenon for many companies around the world selling non-essential goods).

Despite the recent drop in sales, Pakistani car companies have increased their prices. They have defended their decision to do so on the basis that the rupee depreciation since 2018 has increased their production costs. What they fail to point out is that while the Pakistani rupee has depreciated against the US dollar by around 25 percent between July 2018 and July 2020, new car prices have on average increased by more than 25 percent in this time period. A case of heads we win, tails consumers lose!

Market power allows certain firms to jack up retail prices that increases the cost of living. However, there is also a secondary inflationary impact because of their partial foreign ownership: by repatriating outsized profits to parents these companies add to the current account deficit thereby tending to weaken the foreign exchange value of the domestic currency. A depreciating exchange rate has inflationary consequences for the home country aside from increasing the burden of foreign debt.

Stifling competition also means fewer jobs being created and therefore greater unemployment. It also adds to income inequality as well-heeled shareholders benefit from the monopolists’ ability to pay a steady stream of higher dividends. Workers, especially top management, can be compensated handsomely which benefits insiders working for these companies – albeit at the expense of consumers who lose out. This is income redistribution but not of the sort that most economists would countenance.

Apologists for these market giants point to their beneficial socio-economic impact by citing the number of jobs they have created both directly and indirectly and how much they pay in tax revenues.

What this type of defence implicitly assumes is that money currently being spent on such firms’ overpriced offerings would otherwise vanish into the ether or get stuffed into mattresses thereby adversely affecting economic activity. However, if a consumer saves say, Rs500,000, on the purchase of a car they may well spend this for instance on home improvements – thereby injecting money into small and medium sized businesses providing furniture, household fixtures, etc. That in itself will generate greater employment and incomes and build up the local business ecosystem imparting greater resilience to the domestic economy.

While the Competition Commission of Pakistan (CCP) appears to have a grip on various forms of monopolistic practices as it emphasizes on its website and through its annual reports, its presence still appears to be an irritant to large firms with multinational connections rather than a deterrent as many of these firms have found ways to sidestep any significant restrictions on their business practices. For one, because monopolies and oligopolies have enormous resources at their disposal, they can afford to hire the best legal talent in the country to thwart legal challenges in the courts.

One area that needs greater attention is Pakistan’s proclivity to lay out the welcome mat to all forms of foreign investment as long as foreign currency is involved. While a case can be made for foreign investment by firms bringing in technology that the country needs, such as cell phone companies (think the fintech phenomenon), can the same be said for companies making, say, burgers or fried chicken?

Why carry the recurring burden of royalty payments and profit repatriation in foreign currency when the outcome for the country is merely a better quality of French fries? This is where the Chinese model of only allowing foreign investment that provides technological upgradation and/or increases exports is a model worthy of emulation.

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