Market Concentration and Monopoly Power in the Manufacturing Sector, India 1999-2013

Market Concentration and Monopoly Power in the Manufacturing Sector, India 1999-2013

Abstract

The background to this study has been carried out by describing and examining the nature of market concentration and degree of monopoly power in the Indian manufacturing industry. To examine the market structure we have used the HHI index, CR4 index and Mark-up index.Growth rate of CR4 has been more than the growth rate of HHI indicating the market is becoming increasingly skewed and biased towards big corporations. This study using firm level 3 digit classification datafrom ASI and CMIE serves the purpose of understanding the trends in market concentration in the manufacturing industry. It also explains and discusses key aspects tochoice of variable explaining of concentration across industries. The study finds an increasing level of market concentration and the exercise of the degree of monopoly power consistently over the period of time by the monopolistic firms and also differentiates between them.

JEL Code: L00, L1, L12, L13

Keywords: Hirschman Herfindahl Index, Concentration Ration Four Index, Mark-up

1.1 Introduction and Literature review

Competition is percieved to be good for the performance of firms, this is clearly visible from the recent reforms and policy measures taken by the Indian government concerning among other things liberalization and privatisation of markets and abolishment of barriers to trade[1]. Although there are enough evidences to prove the importance of competition for productivity and social welfare, there are arguments against competition, as the effect of competition on productivity is ambiguous and limited (OECD, 2008). A clear cut definition of competition is yet unclear because of the forms which competition may take, hence it is more interesting to understand the manifestations of competition rather than understanding the definition of competition. This chapter focusses on the competition of major manufacturing industry groups in the product market. Thus competition here implies competition amongst firms for a larger market share. Perhaps the most obvious way of competition for the demand of the products is by lowering prices. Soon as we introduce the concept of prices in the model, we have to understand what price is the most condusive price for a firm to charge in a competitive scenario. The idea of perfect competition gives the answer in the sense that price equals marginal cost. At marginal cost the firms pricing is at the equilibrium. But in real world price are set above marginal cost and abnormal profit are realised by firms, how does this happen?

It is hypothesized that market would be imperfect and levels of concentration would be higher than in sectors where competition is higher. The analysis of trends in concentration in Indian maufacturing reveals the existence of high inequalities pointing to the imperfections in the market in terms of industrial development across manufacturing sectors. Using the CMIE prowess database 1999-2013 and the ASI three digit Industrial classification, concentration levels have been worked out using Hirschman Herfindahl index (HHI), Four Firm concentration Index (CR4) and Mark-up (Weighted price cost margin Index) for each year. The analysis has used the following variables viz

(i) Number of firms

(ii) Sales of Individual firms

(iii)Profit after Tax

(iv) Raw Material cost

(v) Power and Energy cost

(vi) Salaries and Wages

Data is obtained from the CMIE databse and given the absolute, relative size and number of firms an attempt is made to show differences in the disposition of market concentration in the manufacturing industry. The first objective of this chapter is to use the HHI and CR4 index to measure the level of concentration across firms. For interpretation purposes HHI has been preferred over CR4 as it is more sensitive to variation among all firms of different sizes. The second objective is to see the relationship between HHI and Mark-up. It has tremendous significance in explaining the theory of markets where industries with higher levels of concentration are expected to earn higher profits due to a higher PCM.

It is understood that the implication of deregulation and economic liberalisation on the concentration levels would differ across industries owing to the nature and the relevance of the industries. The need for industry specific competition policy seems to be the need of the hour (Hellwig, 2008). Industry specific competition policy[2] is quite common in developed countries where we have regulated and unregulated parts of the same industry. Many developing countries including India have felt the need to adopt these policies and approach; one among them is the ‘Competition bill’ in this direction.

Literature review

Most cursory survey of the literature on the market structure in India reveals the lack of studies done in the field of market structure and concentration. There have been a few studies on the impact of economic reforms on industrial concentration, one such study is by Singh (2012). His study has focussed on analysing the trend of concentration of Indian manufacturing using ASI data for major industry groups and considering gross output as the sales value. This study is limited in the sense that it analyses only the gross output of industry to arrive at HH index, and does not say anything about the degree of concentration of industries. It does not look for the relationship among the indicators of concentration and monopoly power.

Mishra (2009) explains the relationship between Mark-up and concentration in the manufacturing industry. This study is important in the sense that it explains how an increase in the level of concentration has an impact on the Mark-up earned by firms. A positive relationship between market concentration and the Mark-up is derived in his study. The study takes into account different factors that influence Mark-up viz growth of sales, advertising, marketing, R&D, import and export competitiveness along with concentration. There are certain problems in the analysis; the concentration index used is CR4 index which undoubtedly is a widely used to asses market concentration, but the index is predictor of concentration and the level of market share of four largest firms. It does not clearly explain the degree of inter-firm inequality in sales such as the HH index, and does not explain the monopoly power of firms.

Mishra and Behera (2007) have studied the market concentration of manufacturing industries in the post liberalisation era. They have used the time series unit root test to examine the instabilities in market concentration. Their analyis has found market concentration to be unstable across major industry groups. Their study has used certain variables determining market concentration; advertising, marketing, R&D, import and export competitiveness and they have shown that advertising, marketing and R&D have positive impact on market concentration. Imports as well as export competitiveness have negative impact on market concentration. They have used ‘Random Effect’ model to asses the time path of the impact of explanatory variables on market concentration. The overall impact of variables seem positive with the impact of positive variables being stronger than the impact of negative variables. There have been a few studies of concentration in the banking industry, but this research is not significant to the proposed area of study, as this study is concencerned with manufacturing industry and not with the services sector.

Post liberalisation experience

(Desai, 1985) has shown that most Indian industries were competitive, with a small number of firms having dominant market shares but a large number of firms with marginal market share. In such a situation, entry of new firms might not alter the extent of concentration, but effective competition would go up.

In its quest for industrialization, the post independence Indian economy adopted a complex mix of protective policies, industrialisation models, and regulatory controls. A strong belief in the socialist mode of industrial development was evident. In general, the empirical evidences show that these policies failed to provide an efficient mechanism for allocating domestic resources in the economy. More than three and half decade of protectionism and import-substitution has left a legacy of high levels of industrial concentration and the accumulation of economic wealth among a small number of families and firms, (Mishra, 2011). It has likewise left a legacy of a lack of a culture of competition that is characterized by a weak and underdeveloped competitive framework. Although there have been laws and acts forbidding monopolies and cartels such as the MRTP Act and Industrial Disputes Act; India does not have a laudable history of fighting against these illegal activities. As evidenced by the lack of cases litigated in Indian courts against monopolies and cartels, and even in the consumer courts the fast tracking of cases has been subservent.

Domestic firms had since then grown accustomed to government sanctioned monopolies and industrial licensing raj together with price controls and government protection. In general anti-competitive business practices had been accepted as part of the normal course of doing business in the country. Rather than competing with imports and focusing on efficiency improvements, firms tended to hide from the challenges of market competition, by engaging in collusive acts and intensive lobbying for more government protection.

With the demise of the import substitution model and the inception of export promotion policy for economic development, the government has been prompted to institute economic policy reforms consistent with the requirements of a competitive market environment. Since the 1980s, it has carried out economic reforms through liberalization, privatization, and economic deregulation; removing unneccesary trade barriers, heavy import duties and abolition of the licensing system. All of theseare aimed at removing barriers to competition and promoting factor mobility and firm growth, securing both high and sustained economic growth.

In the light of the above analysis, the main objective of the chapter is to examine the trends in market competition, and performance of the organised manufacturing sector since the reforms. The chapter also focusses on differentiating the concentration index from the monopoly power index by theoritically and means of correlation between the indices. Detailed study of concentration in all the eight major manufacturing Industries is also done for the period 1999-2013.

1.2 Market concentration indices:

Market concentration is a result of imperfections in terms of price and cost, viz. imperfections of assymetric information and imperfection in substitution of commodities and these imperfections accruing to the ability of the firm to completely differentiate their product from others. Product differentiationleads us to the study of indicators which reveal the imperfection in the market. These imperfections are reflected in the market size and the profits of firms in the following manner:

1.2.2 Herfindahl Concentration Index as used in this study

Herfindahl Concentration Index is defined as the sum of square of market shares, implying an industry with one firm has HHI equal to 1, whereas a herfindahl close to zero implying a large number of firms in the industry with all firms having a equitable market share. An increase in the HHI value implies a increase in the level of market concentration in the firm and decrease in the HHI implies a decrease in the level of market concentration. A reduction in concentration implies an increase in the level of competitiveness of the firms as explained by Polder, Veldhuizen, Bergen Pill (2009).

Herfindahl can only be calculated using the micro data of firms sales value, hence we have considered the four digit level classification using NIC codes for firms using the CMIE data to calculate the HH index. HHI calculated in this study is particular to every industry. It is industry specific and calculated for eight major manufacturing industries for the time period 1999-2013. The formula used to calculate HHI for this study is

Notations as used above

1.2.3 CR4 index as used in this study

CR4 index measures the market concentration as the ratio of the sales of top 4 firms over the total sales of the industry and measures the aggregate market share of the four firms. It is a widely used index of market concentration and is different from HHI as it is less affected by the number of firms in the market. The difference between these indices is the basis for using them separately in this study. HHI deals with all the firms in the industry and we can infer about the difference between two firms by looking at the HH index, which is the primary objective of this chapter. The problem with using CR4 for overall analysis is: Consider two industries, A and B, both with a CR4 of 80percent. However, the fourlargest firms in industry A each have a market share of 20%, while in industry B the largestfirm has a share of 65% and the next three firms each have shares of 5%. Clearly we wouldthink of industry B as far more concentrated than industry A, even though they have the same CR(4). Therefore for we have used HHI as a measure of concentration for the overall analysis of the industry. But for the third chapter due to data inconsistencies and under-reporting we have used CR4 as an index of concentration, also because we do not need inter-firm comparison of concentration for the third chapter.

Here n = 1,2,3,4 top 4 firms in sales

Where C4 is the group of four firms with highest sales value in the industry j. if there is an increase in the value of shares of the top four firms, it means the market has become more concentrated. Similarly a fall in the value implies more competition and lesser concentration, Polder, Veldhuizen, Bergen Pill (2009). The validity of the above statement has to be further analysed by looking at CR5 or CR10, as the decrease in the overall sales of four firms might be because of a new firm coming into the fore. Hence if CR4, CR5, CR10 all are decreasing it implies a fall in concentration in real terms across the industry.

Mark-up

1.2.1 Price Cost Margin

Price cost margin (PCM) also referred to as the ‘Lerner’s index’ or the ‘Rule of Thumb Pricing’ (Hall and Hitch, 1955) is an indicator of profitability or the ability of firm to exercise its monopoly power. It reflects the ability of the firm to charge a price above its marginal cost. The argument is; as competition increases firms are required to decrease their price-cost margin in order to survive in the market. Prices of a firm are reflected in the value of sales, but the value of marginal cost is rather hard to calculate and agree upon, therefore from the available data source, CMIE Prowess I have utilised the summation ‘R+L+E’-

R: Raw material and spare and parts cost,

L: Compensation to employee (Salaries and Wages)

E: Energy cost (Power and Fuel charges)

The summation of these three variables is substracted from the sales value divided by sales value itself to calculate Mark-up which is an Indicator of the firms monopoly power.

Caculated as

Where I and t indicate firm and year

PCMit or Mark-up - Price Cost Margin

Yit : Production value

Lit : Employees cost

Rit: Raw Material and spares cost

Eit: Power and Fuel, Energy cost

For the purpose of this chapter PCM is calculated as a weighted sum of sales of the firms.

Mark-up =

Here :

αit = Sampling weight of firm i

Mshit = Share of firm i in total value of production of industry j, PCM are observed to be larger than one for micro data hence not used.

1.2.4 Profit after Tax

The reason of inclusion of profit after tax in the model as a measure of concentration lies in the ability of firms to earn anything beyond zero economic profit1. Anything beyond zero economic profit for a firm entails monopoly power in the hands of the firm. Firms use this monopoly power to charge a price beyond marginal cost. It is not necessary for firms to earn positive profits all the time, firms indeed earn negative profits2 as well. All negative profits as outliers have been removed from the sample set to avoid inconsistency in the data set: only those outliers have been removed for firms which do not have a significant contribution to the sales value of the industry j.

Zero Economic Profit = Y – (MPL*L) + (MPK*K)

Number of firms:

The data sources used in this study is from the Centre for Monitoring Indian Economy (CMIE). The study is done for the latest data available from a the balance sheet of consistently data reporting firms. The sample consist of Eight manor manufacturing industries as is detailed below. Number of firmsin an industry is an indicator of the level of competitiveness . As we reduce the number of firms in an industry the concentration increases. Monopoly being single seller, duopoly being two sellers, oligopoly being more than two but limited number of sellers, monopolistic market being where there are a host of sellers and hence more firms implying more competitiveness.

The first impact of abolition of import licensing, reduction in tariff rates, abolition of industrial licensing, liberalization of restrictions on foreign capital and the impact of these significant changes can be cited by the establishment of firms post reforms as compared to the pre reforms era. For this analysis, the year of incorporation data has been taken from Prowess post 1960 till 2013 to see the absolute changes in the number of firms.

Fig 1: Number of firms entering the market, post 1961

Source: CMIE prowess

The maximum number of new firms entering the manufacturing industry is after the NEP1991. The impact of liberalisation in the late 80’s is also evident. There is more than 100% increase in the number of new firms during 1980-1990. Food and Agro industry registered more than 200% growth in the number of new firms after the NEP. Globalisation and opening up of the domestic market to foreign manufacturing, the emergence of Pepsico, Coca Cola et all has a major impact on the nature of FMCG industry. Chemical and Drugs industry also saw a surge of sales in the late liberalisation phase with a growth of more than 300% in new firms. All the other industries have also seen an increase in the number of new firms during the two decades 1980-2000. After 2000 there is a decline in the number of new firms in the industry, showing signs of barriers to entry and market concentration, thus the study of concentration via the number of new firms in the industry is important one in order to determine the level of concentration