Ukrainian President Viktor
Yushchenko scored a major victory last week when the government
auctioned off the Kryvorizhstal steel mill for more than $4.8
billion despite the protests of the opposition and a series of legal
challenges filed by the winners of an auction held last year.
Competition among the bidders was so intense that the mill sold for
twice the opening price and more than five times what it went for in
2004, when a consortium led by former President Leonid Kuchma's
son-in-law Viktor Pinchuk bought Kryvorizhstal for $850 million.
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The sale was a
political victory over Yushchenko's domestic opposition, especially
when you take into account that the privatization effort was
spearheaded by former Prime Minister Yulia Tymoshenko. By holding a
normal privatization auction, Yushchenko also achieved something
that his rivals in Russia have never managed to do.
Politics aside, a number of purely economic lessons
can be drawn from the Kryvorizhstal auction. The most interesting of
these is the impact it will have on the metals market in the
Commonwealth of Independent States, but this will not become clear
for another few years, so let's focus on the economics of the
auction itself.
There are two main dangers involved in holding a
privatization auction of this sort: collusion between the bidders
and corruption among the organizers. Collusion is a particularly
serious problem because in certain circumstances bidders don't even
need to form a secret alliance in advance. They can bid in such a
way that a ring or alliance takes shape in the course of the trading
session. The second danger is that the organizers of the auction set
the rules in a way that gives one bidder a clear advantage.
Foreign bidders, including Russian companies, were
effectively barred from participating in last year's Kryvorizhstal
auction on the usual pretext of defending national interests.
Restrictions of this sort, like collusion between the bidders,
result in less profit than if the auction had been conducted on the
up-and-up. Auctions run by the state are particularly vulnerable to
both collusion and corruption because the government officials in
charge have little incentive to encourage aggressive bidding or to
secure the highest price.
The key to the success of last week's auction was
allowing foreign steel producers to participate. This reduced the
risk of collusion because it becomes harder to form alliances as the
number of bidders increases. It also limited the risk of corruption
by decreasing the advantage to be gained by cutting a deal with the
organizers.
In theory, ascending-bid open-format auctions, where
bidders successively raise the sale price until just one bidder
remains, are more susceptible to collusion than sealed-bid auctions.
But sealed-bid auctions are more vulnerable to corruption because
bidders are often ready to part with considerable sums in order to
find out how much their rivals have offered.
So what can Russia learn from the Kryvorizhstal
auction? Surely the organizers of the Yuganskneftegaz and Slavneft
auctions, as well as the privatization auctions of the 1990s,
understood how corruption and collusion reduce profits. The lesson
of Kryvorizhstal is for the Russian people, not the bureaucrats. And
what it teaches us is that if the state holds a privatization
auction but doesn't broadcast the bidding live, and disqualifies a
major bidder to boot, you can bet that corruption and collusion are
involved.
Konstantin Sonin, professor at the New Economic
School/CEFIR, is a columnist for Vedomosti, where this comment first
appeared.
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