Thursday, July 1, 2010

Observations from liquor license auctions

The Andhra Pradesh state government raised a massive Rs 6904 Cr in the recently conducted auctions for two-year liquor retail sales licenses for 6596 retail outlets across the state from a record 48600 bids. This is in comparison to the Rs 3200 Cr received for the 2008-10 auctions from 20000 bids.

This means that, coupled with the excise and sales tax receipts on the liquor sold, which is estimated to be double the auction amount, the excise department is expected to be the highest revenue earner for the state government topping the traditional commercial taxes department. These auctions have highlighted several interesting examples of economic incentives at work.

1. Under the existing state government policies, the number of retail licenses have remained frozen at 6596 for almost a decade now. The geographical distribution of these licenses are such that while the towns and cities can have more than one shop, based on the population and some other parameters, only one license is issued in each mandal (the small administrative unit in the rural areas with a population of about 40000 to 1 lakh, of which there are nearly 1100 in the state).

The single license holder in each mandal assumes all the characteristics of a classic monopoly. This automatically contributes towards increasing the premiums on bagging license rights, especially for rural areas. This is borne out by the fact that the rural areas witnessed the most intense competition, evidenced both in the numbers of bidders and the amounts bid. In fact, the higest bid of Rs 5.21 Cr came for a shop in Nadikudi village of Dachepalli mandal in Guntur district and several other bids for mandals were higher than Rs 3 Cr.

In these areas, given their monopoly character, these outlets become the single point dispensing counter for the numerous illegal outlets that invariably dot the rural landscape. Further, given the intimate relationship between crime, liquor, and political power, a successful bid confers on the license holder a powerful source of patronage.

2. Apart from licenses for retail sales outlets, the excise department also issues license for serving liquor - bars in urban areas and permit rooms in rural areas. These license fees are fixed by the government and its revenues are a small percentage of the collections from retail shop auctions. In the rural areas, the successful bidders for retail sales are provided the choice to bid for one permit room (attached to the license holding retail outlet) on payment of some small additional amount. In other words, while there are multiple (though restricted) serving centers in each urban area, there is only one legally permissible serving center in each mandal.

The aforementioned architecture makes retail liquor sales business very constricted, especially at its downstream end. While the outflows (from the retail outlets) are massive and growing, the consumption end is serviced by a limited number of bars and permit rooms. In the absence of adequate numbers of institutionalized formal centers for serving the massive quantities of liquor flowing in, informal centers inevitably spring up. This restriction opens up another parallel market - in illegal "serving rooms" (attached to both licensed retail outlets and the numerous illegal ones). It is an open secret that most, if not all, the retail outlets and their numerous illegal off-springs function as sales-cum-serving centers.

3. In many respects, liquor retail licenses and bar/permit room licenses are complementary goods. Every few retail outlets have to be serviced by some legal serving rooms. A market design where there are downstream restrictions on the numbers of bar/permit room licenses (even as consumption is increasing) is only bound to increase the premium on upstream retail sales licenses.

In other words, the retail license bidders have internalized the (the one legal permit room and illegal serving rooms) benefits that accrues from their ownership of a retail license, and have priced that into their bids.

4. Though the permit room licenses are obtained relatively cheap at the margins (for a few lakhs of rupees in comparison to the crores paid for shop license), it is commonly found that less than half the license holders prefer to take them. Since all of them invariably end up serving liquor in their outlets, those without permit room licenses presumably do so because the cost of evading detection of their illegal activity is less than the price of the permit room license. In other words, especially given the fact that the permit room license itself is relatively cheap, the enforcement officials of the Prohibition and Excise Department are selling themselves too cheap!

5. Interestingly, another contributory factor to the over-sized bids may have been the economic recession which has had the effect of depressing the real-estate market and leaving builders and developers in the search for alternative remunerative investment opportunities. Further, the very large parallel economy resulting from the aforementioned monopoly characteristics offers them an added attraction of acting as an outlet to funnel the massive amounts of black money that had been sloshing around the real estate sector.

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