(This essay was published in South China Morning Post on 8 June 2016.)
Statistical analysis of bidding patterns reveals evidence of rigging in Hong Kong’s residential housing market, according to the Competition Commission, which studied over 700 confidential tender records from 500 maintenance projects provided by the Urban Renewal Authority and the Housing Society.
The Commission wisely cautions that their findings were not conclusive proof of collusion “having actually taken place.”
Nevertheless, the statistical evidence is highly significant. What should the government do? How should the Competition Commission proceed?
Public opinion naturally focuses on greed and insufficient government vigilance to either prevent or stop it. Greed is, however, a very poor predictor of the presence or absence of bid rigging and of industry cartelization. Are businessmen who don’t rig and manipulate bids or cartelize any less greedy than those who do?
The bids had been collected from the Urban Renewal Authority and the Housing Society, public organizations that follow government procurement practices. The single most important consideration for public bodies is always accountability. Government procurement practices invariably go for the lowest bid because it is the easiest way of handling public accountability.
The use of private information about the bidders is often avoided out of fear of having to defend the choices in contested decisions. The natural outcomes of this are subsequent cost overruns and suspicious bidding patterns. So it is hardly surprising that the Competition Commission discovered persistent patterns of underbidding.
Another concern of public officials is whether the winning bid will successfully complete the project. If one has to go for the lowest bid while also trying to minimize the risk of the project failing, then one would always pre-qualify bidders with a strong track record.
As a consequence, the government procurement process unavoidably sets up barriers to entry that favor industry incumbents and cut down competition.
Even when pre-qualification is not used, the long bureaucratic delays in getting paid or the posting of substantial bonds for public projects would deter smaller companies and newcomers from bidding. Only industry incumbents that can navigate the process and afford costly bonds and bureaucratic procedures will survive the game.
In a nutshell, the public bidding and procurement process is not designed to encourage competition, but to address public accountability concerns and minimize the failure risk. Industry cartelization and bid rigging result from this, making it difficult for new and small businesses to enter the game.
Take the example of estate renovation work, which has become exorbitantly expensive since 2012 when it became mandatory to carry out inspections on all private buildings older than 30 years. Contractors and sub-contractors must be chosen from an approved list, which is a hugely effective barrier to free entry. Even if the list is updated periodically, the barriers are likely to be insurmountable for newcomers.
The Competition Commission could learn from the Independent Commission Against Corruption, which regularly reviews government regulations to minimize the probability they will lead to opportunities for corruption. The Competition Commission could similarly review government regulations and procedures, including bidding rules and the criteria used, to see if they reduce market entry, induce cartelization and lower economic efficiency, and impede competition.
In 2011, I wrote against the enactment of a competition law fearing that it was more likely to impede market competition rather than promote it. I have always believed that the most uncompetitive features of market competition in Hong Kong are due to government regulations and government monopolies. And these are pervasive, from the market for school textbooks to planning rules in development.
Greed does lead to competition, but competition may be so cutthroat that businesses wish to limit it through cartelization. Cartelization is costly and difficult without the help of government regulation to limit market entry.
Two years ago The Economist magazine designed an index of crony capitalism, based on the idea that some industries are prone to “rent seeking”—extracting more profit than they would get in a competitive market. Cartels, monopolies and lobbying are common ways to extract rents, and industries that are vulnerable to this often have a lot of interaction with the government or are licensed by it. Hong Kong was ranked first in the world.
Government regulations are the key source of most forms of non-competitive market practice in Hong Kong. Key sectors in the economy suffer from this ailment, and it would be a great service if the Competition Commission would use its powers granted by legislation to bring about some improvement.
