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Offest, Barter, and Countertrade In December 2002, Poland decided to purchase 48 F-16 Falcons from Lockheed Martin Corporation - an American defense contractor. Pegged at $3.5 billion, this is the biggest defense order ever issued by an east or central European country. The financial package includes soft loans and a massive offset program - purchases from Polish manufacturers that more than erase the costs of the deal in foreign exchange. Offset in all its forms - including co-production, licensing, subcontracting, and joint ventures - is not uncommon in the defense industry. It is being offered even to far richer clients such as Israel. But in central and east Europe it is more prevalent than the West realizes. According to numerous studies, barter-like arrangements (known throughout the region as "compensation") constitute between 20 and 40 percent of all transactions in the economies of the former Soviet bloc. Corporate debts to suppliers, payments for goods and services, even taxes - all have a non-cash component or are entirely demonetized. The implosion of communism led to a rapid shrinking of the manufacturing base and the evaporation of the agricultural and mining sectors in many countries in transition. Export-derived earnings in hard currency collapsed even as millions lost their jobs and their purchasing power. Unemployment affects one fifth of the population in Poland, one third in Macedonia and three fifths in Kosovo, for instance. Rather than remonetize these cash-bleeding economies, the IMF imposed strict austerity programs on the entire area, further eroding disposable incomes and intra-regional trade. Countertrade, barter, buyback, offset, clearing, technology transfer and other non-cash dealings flourished. Moreover, the clearing system of the now defunct eastern trade bloc, COMECON - the Council of Mutual Economic Assistance (CMEA), was based on effective barter and the use of a fictitious "wooden" ruble. From Hungary to Cuba, communist countries were coerced into outlandish terms of trade, often beneficial to the Soviet Union or to a member in need. Mounting debts led to the disintegration of the entire edifice and Russia was reduced to giving east European countries aircraft and other weapons systems in lieu of cash disbursements. Russia reimburses Kazakhstan with (shoddy) goods for leasing the Baikonur Cosmodrome. Until 2000, it was common practice in the Russian Federation to pay wage arrears, inter-enterprise debt and back taxes in kind. Russia and Turkmenistan accept food and other commodities, semi-finished products and construction services from Ukraine, Armenia and Belarus in exchange for their gas debts and, in Russia's case, for disposing of Ukraine's nuclear waste. The recipients often complain of the quality of the products or services they receive - and of recurrent breaches of delivery schedules and quantities. But they have little choice. Ukraine is one of Turkmenistan's major export clients, for instance. Nor are these exchanges post-communist phenomena. Canadian firms, led by AECL - Atomic Energy of Canada Limited - were forced to accept Romanian goods for their nuclear reactors throughout the late 1980s. There is a general misconception that barter is a thing of the past. Far from it. In the last six months, payments-in-kind to Gazprom, the Russian energy behemoth, have tripled due to an increase in its tariffs. The use of "veksels" (mostly corporate promissory notes) surged 60 percent. Hence the rise to prominence of barter experts, such as Igor Makarov, who, as general manager of Itera, oversaw Gazprom's sales of gas throughout the Commonwealth of Independent States. As prices are adjusted to reflect waning state subsidies, consumers' purchasing power diminishes and countertrade transactions burgeon. A global recession coupled with the woes specific to transition from communism to capitalism herald an era of unmanageable inter-corporate debt. In tiny Macedonia, it is thought to have surpassed $600 million last year - close to one fifth of GDP. The bulk of such debt is ultimately settled by barter. Proponents of barter trade - mainly a proliferation of Western consultancies, financial boutiques and trading companies - count their advantages thus (from the Export911.com Web site): "Countertrade provides a means of trade with countries using a blocked currency - currency that is not readily convertible into other currencies - or lacking the foreign exchange, thus removing the difficulties and risks in a trade financing and paving the way for a successful deal that otherwise would fail. Countertrade also provides a means to preserve foreign exchange reserves by eliminating the use of hard currency." The US Embassy in Moscow counters by describing the nefarious effects of barter on the Russian economy: "In Russia, the barter system is used for various reasons: monetary risk, lack of money, illicit enrichment, tax evasion and to continue business operations beyond viable economic life. The system creates numerous negative effects, namely: low tax receipts, price distortions, oversupply of products, ineffective monetary policy instruments, imprecise economic measurements, and, as a consequence, poor public policy decisions. Barter is tolerated and sustained because of short-term management perspectives, its value as a social safety valve and poor application of bankruptcy laws." The demonetization of the economy and the distortion of the price signal (which ensures the proper allocation of economic resources) are not the only pernicious effects of non-cash business. Barter transactions tend to enhance the militarization of the region. No one wants Russian TV sets or Ukrainian stockings. But MiG fighter planes and Kalkan and Grif patrol boats are in great demand. Turkmenistan, for instance, has built an entire Caspian Sea coast guard out of its gas-for-goods agreement with Ukraine signed last year. Non-cash transactions are an integral part of the informal sector of the economy, estimated to constitute at least one third of the region's total gross domestic product. They are impossible to track, let alone tax. They are conducive to capital flight and offshore stashing of export proceeds. Technically, barter deals are a kind of non-tariff barrier as they interfere with the free market by binding specific buyers to given sellers. Hence the recent Russian-Chinese agreement to ban non-cash transactions in their border areas. Countertrade deals are complex and multi-phased. If improperly structured, they leave a lot of space for corruption and worse. Radio Free Europe/Radio Liberty reported that the military court of the Moscow garrison sentenced in April 2002 the former head of the Defense Ministry's Main Directorate of Military Budget and Finances, Colonel-General Georgi Oleinik, to three years in prison. In a typical scam - oft-repeated in Chechnya - Oleinik absconded in 1996-1997 with some $450 million. The money belonged to Ukrainian firms and was paid out in the framework of a multistage barter deal. It was earmarked for the purchase of materiel for the Russian army. Interestingly, in his defense, Oleinik insisted that the deal was authorized by former Finance Minister Andrei Vavilov and other senior officials. Still, in the long-run, barter is doomed. As more former Soviet satellites either divert their trade towards the European Union or join it as members, countertrade will be restricted to the financially backward economies of the former Soviet Bloc. In time, even these laggards will have to face market realities - especially the use of cash as the foundation of the price mechanism and the optimal allocation of scarce economic resources. Put vernacularly, the citizens of barter-addicted countries will inevitably grow disenchanted with shoddy and shabby goods delivered late. Imports from and exports to cash paying destinations will surge. "Ghost" factories will close down, releasing capacity to more productive entrants. Cash-starved governments will deepen and widen tax collection. A foreign-owned banking system will do a better job of matching savings to investments. Barter will be reduced to a marginal, last resort, activity. Oil, Price of Hedging The price of oil is no longer an important determinant of the economic health of the West. Today, there are forward contracts, which allow one to fix the price of purchased oil well in advance. There are options contracts which can be used to limit one's risks as a result of trading in such forward contracts. In other words: If one loses money on the forward contract because the purchase price fixed in the contract is higher than the market price at the time of delivery (=one must pay more than the market price according to one's obligation in the contract) - one makes a profit on the options contract that is similar to the loss on the forward contract. Thus, if one uses forwards plus options - one fixes a price in the future that can be not too far from the market price at the time of delivery. Such financial positions require sophisticated management and day to day maintenance of the forwards and options positions, though. Fixing Oil Prices Inside Countries Most countries in the world have three systems of fixing prices inside their markets:
The Price Trends of Oil The international price of oil is determined by the following factors: (NEGATIVE=depresses prices, POSITIVE=increases prices)
Oligarchs (Chubais) Even by the imperceptible standards of eastern Europe, the crony-infested Russian version of "privatization" was remarkable for its audacity and scope. Assets now worth some $25 billion were sold for c. $1 billion. A later loans-for-shares plunder was micromanaged by Anatoly Chubais, head of the State Property Committee, then heralded by the West as a "true reformer". Chubais enjoyed casting himself as the lonely champion of the rule of law and private property fighting an uphill battle against shady oligarchs and a resurgent communists. Ever since then, Chubais has been entangled in a series of scandals. In 1997 alone, his name was robustly linked to two. One revolved around an outlandish $450,000 advance paid to Chubais and two co-authors by a publishing firm later taken over by a bank, Uneximbank, one of the main beneficiaries of Chubais' privatization shenanigans. The second outrage involved the now-defunct Harvard Institute of International Development (HIID), headed by the much-interviewed Jeffrey Sachs. The Institute enjoyed well over $60 million in USAID funds as it worked hand in glove in the early 1990s with Chubais to shock Russia into economic "therapy" through the Russian Privatization Center. The outcome has been calamitous. It took Russia almost a decade to recover from the involvement of these "experts" in its economy. Moreover, often, practice and preaching were far apart. In a bout of puzzling honesty, Chubais admitted, in an interview to the Russian business daily Kommersant, later published also by the Los Angeles Times, to defrauding multilateral lending organizations and their Western masters. He said: "In such situations, the authorities have to (lie). We ought to. The financial institutions understand, despite the fact that we conned them out of $20 billion, that we had no other way out." Andrei Shleifer and Jonathan Hay, two Harvard professors, were caught, as a $120 million lawsuit filed by the American authorities, under the False Claims Act, in September 2000, alleges, "abusing the trust of the U.S. government by using personal relationships...for private gain", purportedly shared with Chubais and his crew. It is a sad testimony to both Russia's dearth of honest talent and to the murkiness of its public life that Chubais is as strong as ever and manages the giant electricity utility, UES. In the dismal landscape of Russian business, Chubais is a managerial star and role model. With a self-declared annual salary of a mere $4,000, this job is, apparently, yet another personal sacrifice of many. As the Moscow Times recounts, Chubais plans to split the current inefficient electricity giant into an independent transmission grid company, a system operator and several generation companies (gencos), all directly owned by the government and minority shareholders. A single holding company will consolidate the stakes that UES holds in regional energy companies. UES will, in effect, end up controlling the national grid. Initial, legislative and administrative, steps to implement this scheme have already been taken. Yet, Chubais' checkered past and even more checkered friends render him automatically suspect. Everything he says makes incontrovertible economic sense. Power generation, the national and regional grids, the pricing structure, the cost of fossil fuels - all require nothing short of an agonizing transformation. But Chubais' history of ulterior motives invariably invokes the question: what's in it for him? Why is he so bent on disposing of UES assets at bargain basement valuations, since electricity prices have not yet been adjusted to reflect costs? According to The Economist, the very foreign investors that Chubais so clamors for may be shunning a UES dominated by him. Many of them remember the attempt they thwarted a few years back to sell generators on the cheap to local tycoons in favor or his dubious ties to the aluminum industry, a heavy consumer of electricity. Others were shocked by a contract signed with Renaissance Capital, owner of 25% of a UES subsidiary, Kuzbassenergo, granting Renaissance cheap generation capacity in future tenders. Such qualms aside, foreign utilities and Russian oil companies, though, would find a UES divestiture irresistible. In the best of Russian traditions, Chubais is busy expanding his fief and preparing for yet another round of self-serving "restructuring". This is not without precedent. Viktor Chernomyrdin, an erstwhile Russian prime minister, similarly leveraged his management of Gazprom, Russia's energy colossus, between 1989 and 1992.
A - just - complaint Chubais penned regarding
inflated pricing and predatory business practices of Mezhregiongaz, Russia's
natural gas monopoly, led to an audit order by Kremlin-appointed Alexei Miller.
This could weaken Putin's St. Petersburg pals and strengthen guess who. Consider destitute Bashkortostan. Last week its power grid, BSK, resolved to establish a joint stock company and to spin off the management, sales and maintenance functions to separate entities. The outcome of the upheaval? UES would become the second largest shareholder of BSK. A similar deal regarding Mosenergo was struck last month with a reluctant Yuri Luzhkov, Moscow's mayor, after much acrimony. The municipality will enhance its share of the lucrative power generation business by investing in it "assets" valued at "market prices". Takeovers of fossil fuel companies led Chubais to confrontations with politicians and oligarchs throughout the vast land. In 1999 he clashed with the late Alexander Lebed, governor of Krasnoyarsk Krai, over the control of the Krasugol, the regional coal extractor. Lebed ultimately won. Chubais is a man for all audiences. On the one hand, in the penumbral corridors of power, he presses for a vertiginous hike of electricity prices to enable him to attract investors for his plan to invest $50 billion over the next decade in modernizing the network. On the other hand, in interviews to the media, he denies any such intentions. "I am sure no boost in prices either before the reform or after it can threaten us ... (my reform proposals) will undoubtedly lead to a decline in the prices" - he reassured the public in an interview to RTR Television, quoted by Interfax on October 19. What lurks behind Chubais' undisputed sway? When UES raised tariffs in flood-stricken areas to recoup the costs of restoration work - Russia's President, Vladimir Putin delivered a vitriolic diatribe against the behemoth. Yet, not daring to confront Chubais directly, he instead castigated his hapless deputy, Andrey Rapaport. The pro-Kremlin factions in the Duma passed, in September 2001, a resolution calling for an investigation of UES' upper echelons. Again, Chubais went unnamed. UES contributes to the federal budget c. $1.5 billion annually - the equivalent of the entire defense outlay. But such compulsory corporate largesse does not depend on the identity of the utility's management. Business Week described, in January, a meeting between the Swedish-born director of Prosperity Capital Management, Mattias Westman, and Putin. The Russian President boasted that he has blocked Chubais' ability to asset-strip UES and distribute the goodies to his regional cronies.
"When a Westman aide asked what Chubais'
managers had received in return for accepting this change, Putin answered in a
deadpan tone: 'I have agreed that they can keep their jobs.' With that, Westman
recalled, Russia's President nearly fell off his chair laughing." "Compared with pre-crisis January 1998, Russia has seen a productivity boom that makes US productivity growth appear lethargic ... Russia's industrial transformation runs counter to prevailing ideas about enterprises after communism. Many thought big Soviet industrial enterprises so hopeless that they were best abandoned, as widely occurred in central Europe. Russia's mass privatisation was condemned as an economic disaster ... But Russia has put all this conventional wisdom into question. Privatisation is the root cause of Russia's enterprise restructuring. Whereas only 10 years ago Russia's industry was fully state-owned, today 90 per cent of it is privatised and 61 per cent of the companies have one controlling shareholder group. All of the success stories are private enterprises. State-owned companies remain a remarkable failure." But this is a counterfactual self-interested minority view not held even by foreign investors. The legacy of the botched privatization process in the early 1990s is an anti-competitive marketplace, governed by monopolies and duopolies, closely owned by an elite of insiders who regularly abuse minority shareholders, the state and the rule of law. The World Economic Forum rates Russia 64th out of 80 countries in growth competitiveness. Russia made it to the abysmal 135th place out of 156 nations on the 2003 Index of World Economic Freedom, compiled by the Washington-based Heritage Foundation and The Wall Street Journal. Nor is GDP growth a proxy for productivity growth, as Aslund erroneously states. The Russian market is far from free. In the Oct 10 issue of the RFE/RL Russian Political Weekly, David E. Hoffman, The Washington Post foreign editor and author of "The Oligarchs: Wealth and Power in the New Russia" (Public Affairs, 2001), stated: "(The) structure of the economy ... remains dominated by large industrial groups. Peter Boone and Denis Rodionov, in their recent paper, provide good evidence of this. They found that Russia's economy is still structured around the kind of large oligarchic groups which took root in the 1990s. Of Russia's top 64 companies, where the government no longer has a controlling stake, 85 percent of the value is controlled by just eight shareholder groups, which generally hold 40 percent-100 percent stakes in the companies they control." Business in Russia is still largely into rent seeking and profitable collusion with the elites: politicians, the security services, the army, regional governors. These mildly functioning enterprises - not as remotely thriving as Aslund makes them out to be - arose despite the looting, overseen by Chubais, of state assets by insiders and organized crime - not because of it. Most of the successful privately owned conglomerates and firms in Russia have been shaped by favorable terms of trade, rising oil prices and a process of streamlining induced by the implosion of the economy in 1998. The discipline imposed by vocal minority shareholders - both foreign and domestic - and punitive capital markets has also helped. In September, Chubais announced a freeze on all asset disposals. Andrei Illarionov, Putin's economic advisor, who maintains an unblemished liberal reputation, has repeatedly attacked Chubais publicly, recently at the Harvard-sponsored Sixth Annual Russian Investment Symposium in Boston. Chubais cancelled his appearance and other representatives of UES refused to divulge the identity of buyers of UES assets, citing "confidentiality" as a reason. Quoted by Radio Free Europe/Radio Liberty, Illarionov said: "It looks like those people just forgot that they are management, not a group of bandits (who) captured the company. And this management is hired and can be fired, and completely forgot about it. And such is (an) absolutely inappropriate, vulgar, and boorish attitude ... (Chubais intends to create a power monopoly) in the sense of might, in the sense of control, (an) economic and political one." Minority shareholders, such as Hermitage Capital, seek to convene an extraordinary shareholders meeting to get rid of Chubais. Presumably, they enjoy tacit government support. Russia may have finally decided to confront Chubais and his lot, relics of the rot that gripped Russia in the buccaneering phase of its hitherto botched transition. Oligopolies The Wall Street Journal has recently published an elegiac list: "Twenty years ago, cable television was dominated by a patchwork of thousands of tiny, family-operated companies. Today, a pending deal would leave three companies in control of nearly two-thirds of the market. In 1990, three big publishers of college textbooks accounted for 35% of industry sales. Today they have 62% ... Five titans dominate the (defense) industry, and one of them, Northrop Grumman ... made a surprise (successful) $5.9 billion bid for (another) TRW ... In 1996, when Congress deregulated telecommunications, there were eight Baby Bells. Today there are four, and dozens of small rivals are dead. In 1999, more than 10 significant firms offered help-wanted Web sites. Today, three firms dominate." Mergers, business failures, deregulation, globalization, technology, dwindling and more cautious venture capital, avaricious managers and investors out to increase share prices through a spree of often ill-thought acquisitions - all lead inexorably to the congealing of industries into a few suppliers. Such market formations are known as oligopolies. Oligopolies encourage customers to collaborate in oligopsonies and these, in turn, foster further consolidation among suppliers, service providers, and manufacturers. Market purists consider oligopolies - not to mention cartels - to be as villainous as monopolies. Oligopolies, they intone, restrict competition unfairly, retard innovation, charge rent and price their products higher than they could have in a perfect competition free market with multiple participants. Worse still, oligopolies are going global. But how does one determine market concentration to start with? The Herfindahl-Hirschmann index squares the market shares of firms in the industry and adds up the total. But the number of firms in a market does not necessarily impart how low - or high - are barriers to entry. These are determined by the structure of the market, legal and bureaucratic hurdles, the existence, or lack thereof of functioning institutions, and by the possibility to turn an excess profit. The index suffers from other shortcomings. Often the market is difficult to define. Mergers do not always drive prices higher. University of Chicago economists studying Industrial Organization - the branch of economics that deals with competition - have long advocated a shift of emphasis from market share to - usually temporary - market power. Influential antitrust thinkers, such as Robert Bork, recommended to revise the law to focus solely on consumer welfare. These - and other insights - were incorporated in a theory of market contestability. Contrary to classical economic thinking, monopolies and oligopolies rarely raise prices for fear of attracting new competitors, went the new school. This is especially true in a "contestable" market - where entry is easy and cheap. An Oligopolistic firm also fears the price-cutting reaction of its rivals if it reduces prices, goes the Hall, Hitch, and Sweezy theory of the Kinked Demand Curve. If it were to raise prices, its rivals may not follow suit, thus undermining its market share. Stackleberg's amendments to Cournot's Competition model, on the other hand, demonstrate the advantages to a price setter of being a first mover. In "Economic assessment of oligopolies under the Community Merger Control Regulation, in European Competition law Review (Vol 4, Issue 3), Juan Briones Alonso writes: "At first sight, it seems that ... oligopolists will sooner or later find a way of avoiding competition among themselves, since they are aware that their overall profits are maximized with this strategy. However, the question is much more complex. First of all, collusion without explicit agreements is not easy to achieve. Each supplier might have different views on the level of prices which the demand would sustain, or might have different price preferences according to its cost conditions and market share. A company might think it has certain advantages which its competitors do not have, and would perhaps perceive a conflict between maximising its own profits and maximizing industry profits. Moreover, if collusive strategies are implemented, and oligopolists manage to raise prices significantly above their competitive level, each oligopolist will be confronted with a conflict between sticking to the tacitly agreed behaviour and increasing its individual profits by 'cheating' on its competitors. Therefore, the question of mutual monitoring and control is a key issue in collusive oligopolies." Monopolies and oligopolies, went the contestability theory, also refrain from restricting output, lest their market share be snatched by new entrants. In other words, even monopolists behave as though their market was fully competitive, their production and pricing decisions and actions constrained by the "ghosts" of potential and threatening newcomers. In a CRIEFF Discussion Paper titled "From Walrasian Oligopolies to Natural Monopoly - An Evolutionary Model of Market Structure", the authors argue that: "Under decreasing returns and some fixed cost, the market grows to 'full capacity' at Walrasian equilibrium (oligopolies); on the other hand, if returns are increasing, the unique long run outcome involves a profit-maximising monopolist." While intellectually tempting, contestability theory has little to do with the rough and tumble world of business. Contestable markets simply do not exist. Entering a market is never cheap, nor easy. Huge sunk costs are required to counter the network effects of more veteran products as well as the competitors' brand recognition and ability and inclination to collude to set prices. Victory is not guaranteed, losses loom constantly, investors are forever edgy, customers are fickle, bankers itchy, capital markets gloomy, suppliers beholden to the competition. Barriers to entry are almost always formidable and often insurmountable. In the real world, tacit and implicit understandings regarding prices and competitive behavior prevail among competitors within oligopolies. Establishing a reputation for collusive predatory pricing deters potential entrants. And a dominant position in one market can be leveraged into another, connected or derivative, market. But not everyone agrees. Ellis Hawley believed that industries should be encouraged to grow because only size guarantees survival, lower prices, and innovation. Louis Galambos, a business historian at Johns Hopkins University, published a 1994 paper titled "The Triumph of Oligopoly". In it, he strove to explain why firms and managers - and even consumers - prefer oligopolies to both monopolies and completely free markets with numerous entrants. Oligopolies, as opposed to monopolies, attract less attention from trustbusters. Quoted in the Wall Street Journal on March 8, 1999, Galambos wrote: "Oligopolistic competition proved to be beneficial ... because it prevented ossification, ensuring that managements would keep their organizations innovative and efficient over the long run." In his recently published tome "The Free-Market Innovation Machine - Analysing the Growth Miracle of Capitalism", William Baumol of Princeton University, concurs. He daringly argues that productive innovation is at its most prolific and qualitative in oligopolistic markets. Because firms in an oligopoly characteristically charge above-equilibrium (i.e., high) prices - the only way to compete is through product differentiation. This is achieved by constant innovation - and by incessant advertising. Baumol maintains that oligopolies are the real engines of growth and higher living standards and urges antitrust authorities to leave them be. Lower regulatory costs, economies of scale and of scope, excess profits due to the ability to set prices in a less competitive market - allow firms in an oligopoly to invest heavily in research and development. A new drug costs c. $800 million to develop and get approved, according to Joseph DiMasi of Tufts University's Center for the Study of Drug Development, quoted in The wall Street Journal. In a paper titled "If Cartels Were Legal, Would Firms Fix Prices", implausibly published by the Antitrust Division of the US Department of Justice in 1997, Andrew Dick demonstrated, counterintuitively, that cartels are more likely to form in industries and sectors with many producers. The more concentrated the industry - i.e., the more oligopolistic it is - the less likely were cartels to emerge. Cartels are conceived in order to cut members' costs of sales. Small firms are motivated to pool their purchasing and thus secure discounts. Dick draws attention to a paradox: mergers provoke the competitors of the merging firms to complain. Why do they act this way? Mergers and acquisitions enhance market concentration. According to conventional wisdom, the more concentrated the industry, the higher the prices every producer or supplier can charge. Why would anyone complain about being able to raise prices in a post-merger market? Apparently, conventional wisdom is wrong. Market concentration leads to price wars, to the great benefit of the consumer. This is why firms find the mergers and acquisitions of their competitors worrisome. America's soft drink market is ruled by two firms - Pepsi and Coca-Cola. Yet, it has been the scene of ferocious price competition for decades. "The Economist", in its review of the paper, summed it up neatly: "The story of America's export cartels suggests that when firms decide to co-operate, rather than compete, they do not always have price increases in mind. Sometimes, they get together simply in order to cut costs, which can be of benefit to consumers." The very atom of antitrust thinking - the firm - has changed in the last two decades. No longer hierarchical and rigid, business resembles self-assembling, nimble, ad-hoc networks of entrepreneurship superimposed on ever-shifting product groups and profit and loss centers. Competition used to be extraneous to the firm - now it is commonly an internal affair among autonomous units within a loose overall structure. This is how Jack "neutron" Welsh deliberately structured General Electric. AOL-Time Warner hosts many competing units, yet no one ever instructs them either to curb this internecine competition, to stop cannibalizing each other, or to start collaborating synergistically. The few mammoth agencies that rule the world of advertising now host a clutch of creative boutiques comfortably ensconced behind Chinese walls. Such outfits often manage the accounts of competitors under the same corporate umbrella. Most firms act as intermediaries. They consume inputs, process them, and sell them as inputs to other firms. Thus, many firms are concomitantly consumers, producers, and suppliers. In a paper published last year and titled "Productive Differentiation in Successive Vertical Oligopolies", that authors studied: "An oligopoly model with two brands. Each downstream firm chooses one brand to sell on a final market. The upstream firms specialize in the production of one input specifically designed for the production of one brand, but they also produce he input for the other brand at an extra cost. (They concluded that) when more downstream brands choose one brand, more upstream firms will specialize in the input specific to that brand, and vice versa. Hence, multiple equilibria are possible and the softening effect of brand differentiation on competition might not be strong enough to induce maximal differentiation" (and, thus, minimal competition). Both scholars and laymen often mix their terms. Competition does not necessarily translate either to variety or to lower prices. Many consumers are turned off by too much choice. Lower prices sometimes deter competition and new entrants. A multiplicity of vendors, retail outlets, producers, or suppliers does not always foster competition. And many products have umpteen substitutes. Consider films - cable TV, satellite, the Internet, cinemas, video rental shops, all offer the same service: visual content delivery. And then there is the issue of technological standards. It is incalculably easier to adopt a single worldwide or industry-wide standard in an oligopolistic environment. Standards are known to decrease prices by cutting down R&D expenditures and systematizing components. Or, take innovation. It is used not only to differentiate one's products from the competitors' - but to introduce new generations and classes of products. Only firms with a dominant market share have both the incentive and the wherewithal to invest in R&D and in subsequent branding and marketing. But oligopolies in deregulated markets have sometimes substituted price fixing, extended intellectual property rights, and competitive restraint for market regulation. Still, Schumpeter believed in the faculty of "disruptive technologies" and "destructive creation" to check the power of oligopolies to set extortionate prices, lower customer care standards, or inhibit competition. Linux threatens Windows. Opera nibbles at Microsoft's Internet Explorer. Amazon drubbed traditional booksellers. eBay thrashes Amazon. Bell was forced by Covad Communications to implement its own technology, the DSL broadband phone line. Barring criminal behavior, there is little that oligopolies can do to defend themselves against these forces. They can acquire innovative firms, intellectual property, and talent. They can form strategic partnerships. But the supply of innovators and new technologies is infinite - and the resources of oligopolies, however mighty, are finite. The market is stronger than any of its participants, regardless of the hubris of some, or the paranoia of others. OPEC (Organization of Petroleum Exporting Countries) Indonesia's Energy Minister, Purnomo Yusgiantoro, is unhappy with the modest production cut, from June 1, of 2 million barrels per day, adopted by the Organization of Petroleum Exporting Countries last week. He intends to demand further reductions at the June 11 get-together in Qatar. The deal struck is so convoluted and loopholed that actual output declines may amount to no more than 600,000 bpd, assuming, miraculously, full compliance. Quotas were first raised before the war to 27.4 million bpd - a theoretical level, not met by actual supply. Crude prices, entering a period of seasonal weakening, dropped further on the news. With Nigerian and Venezuelan crude recovering from months of strife, this downtrend may be temporary. Global excess capacity is a mere 1 million bpd - one fifth its prewar level. As North American and North Sea production declines, the importance of Gulf producers soars. OPEC's eleven countries - Algeria, Indonesia, Iran, Iraq (suspended in 1990, following its invasion of Kuwait), Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela - control one third to two fifths of global oil output and three quarters of the far more important residual demand - traded between net consumers and net exporters. Residual demand is set to double by 2010. Still, OPEC - led by Saudi Arabia, now off the US buddy list - faces fundamental problems that no tweaking can resolve. Iraq, in the throes of reconstruction and under America's thumb, may opt to exit the club it has founded in 1960 and, thus unfettered, flood the market with its 2.3 to 2.8 million bpd of oil. Iraqi production can reach 7-8 million bpd in six years, completely upsetting the carefully balanced market sharing agreements among OPEC members. This nightmare may be years away, what with Iraq's dilapidated and much-looted infrastructure and vehement international wrangling over past and future contracts. All the same, it looms menacing over the organization's future. Far more ominous perils lurk in Russia, the second largest oil producer and growing. Though the cheapest and most abundant reserves are still to be found in the Persian Gulf, Central Asia and Russia are catching up fast. Ali al-Naimi, the Saudi oil minister may be forced out of office by this apparent crumbling of the organization's stature. This would be unwise. Naimi is widely credited with engineering the tripling of oil prices to more than $30 a barrel between 1998 and 1999. As the informal boss of the state-owned Saudi oil behemoth, Aramco, he has already introduced postwar output cuts. The oil market is so volatile that even marginal production shifts affect prices disproportionately. Naimi is a master of such manipulation. Saudi Arabia regards itself as the market regulator. It keeps expensive, fully-developed, wells idle as a 1.9 million bpd buffer against supply disruptions. It is this "self-sacrificial" policy that endows it with tremendous clout in the energy markets. Only the United States can afford to emulate it - and even then, the Saudi Kingdom still possesses the largest known reserves and sports the lowest extraction costs worldwide. OPEC is, therefore, not without muscle. Saudi Arabia had punished uppity producers, such as Nigeria, by flooding the markets and pulverizing prices. Yet, the organization is riven by internecine squabbles about market shares and production ceilings. Giants and dwarves cohabit uneasily and collude to choreograph prices in what has long been a buyers' market. These inherent contradictions are detrimental. If OPEC fails to recruit another massive producer (namely: Russia) soon - it is doomed. Paradoxically, the Iraq war is exactly what the doctor ordered. OPEC's only long-term hope lies in a geopolitical shift, the harbingers of which are already visible. Russia may join the cartel, disenchanted by an imperious and haughty USA - or the Europeans may "adopt" OPEC as a counterweight to the sole "hyperpower" newfound energy preeminence. America announced its intention to pull out its troops stationed in Saudi Arabia. As this major producer is thrust into the role of the "bad guy" - it acquires incentives to team up with other "pariahs" such as France and, potentially, Russia. Controlling the oil taps is a sure way to render the USA less unilateral and more accommodating. US interest are diametrically opposed to those of oil producers, whether in OPEC's ranks or without. The United States seeks to secure an uninterrupted supply of cheap oil. Yet, a consistently low price level would go a long way towards reducing Russia back to erstwhile penury. It would also destabilize authoritarian and venal regimes throughout the Middle East. This unsettling realization is dawning now on minds from Paris to Riyadh and from St. Petersburg to Tehran. As the United States looms large over both producers and consumers, the ironic outcome of the Iraqi war may well be an oil crunch rather than an oil glut. Organ Trafficking A kidney fetches $2700 in Turkey. According to last month's issue of the Journal of the American Medical Association, this is a high price. An Indian or Iraqi kidney enriches its former owner by a mere $1000. Wealthy clients later pay for the rare organ up to $150,000. CBS News aired, two years ago, a documentary, filmed by Antenna 3 of Spain, in which undercover reporters in Mexico were asked, by a priest acting as a middleman for a doctor, to pay close to 1 million dollars for a single kidney. An auction of a human kidney on eBay in February 2000 drew a bid of $100,000 before the company put a stop to it. Another auction in September 1999 drew $5.7 million - though, probably, merely as a prank. Organ harvesting operations flourish in Turkey, in central Europe, mainly in the Czech Republic, and in the Caucasus, mainly in Georgia. They operate on Turkish, Moldovan, Russian, Ukrainian, Belarusian, Romanian, Bosnian, Kosovar, Macedonian, Albanian and assorted east European donors. They remove kidneys, lungs, pieces of liver, even corneas, bones, tendons, heart valves, skin and other sellable human bits. The organs are kept in cold storage and air lifted to illegal distribution centers in the United States, Germany, Scandinavia, the United Kingdom, Israel, South Africa, and other rich, industrialized locales. It gives "brain drain" a new, spine chilling, meaning. Organ trafficking has become an international trade. It involves Indian, Thai, Philippine, Brazilian, Turkish and Israeli doctors who scour the Balkan and other destitute regions for tissues. The Washington Post reported last week that in a single village in Moldova, 14 out of 40 men were reduced by penury to selling body parts. Last year, Moldova cut off the thriving baby adoption trade due to an - an unfounded - fear the toddlers were being dissected for spare organs. According to the Israeli daily, Ha'aretz, the Romanians are investigating similar allegations in Israel and have withheld permission to adopt Romanian babies from dozens of eager and out of pocket couples. American authorities are scrutinizing a two year old Moldovan harvesting operation based in the United States. Organ theft and trading in Ukraine is a smooth operation. According to news agencies, last August three Ukrainian doctors were charged in Lvov with trafficking in the organs of victims of road accidents. The doctors used helicopters to ferry kidneys and livers to colluding hospitals. They charged up to $19,000 per organ. The West Australian daily surveyed in January the thriving organs business in Bosnia-Herzegovina. Sellers are offering their wares openly, through newspaper ads. Prices reach up to $68,000. Compared to an average monthly wage of less than $200, this is an unimaginable fortune. National health insurance schemes turn a blind eye. Israel's participates in the costs of purchasing organs abroad, though only subject to rigorous vetting of the sources of the donation. Still, a May 2001 article in a the New York Times Magazine, quotes "the coordinator of kidney transplantation at Hadassah University Hospital in Jerusalem (as saying that) 60 of the 244 patients currently receiving post-transplant care purchased their new kidney from a stranger - just short of 25 percent of the patients at one of Israel's largest medical centers participating in the organ business". Many Israelis - attempting to avoid scrutiny - travel to east Europe, accompanied by Israeli doctors, to perform the transplantation surgery. These junkets are euphemistically known as "transplant tourism". Clinics have sprouted all over the benighted region. Israeli doctors have recently visited impoverished Macedonia, Bulgaria, Kosovo and Yugoslavia to discuss with local businessmen and doctors the setting up of kidney transplant clinics. Such open involvement in what can be charitably described as a latter day slave trade gives rise to a new wave of thinly disguised anti-Semitism. The Ukrainian Echo, quoting the Ukrinform news agency, reported, on January 7, that, implausibly, a Ukrainian guest worker died in Tel-Aviv in mysterious circumstances and his heart was removed. The Interpol, according to the paper, is investigating this lurid affair. According to scholars, reports of organ thefts and related abductions, mainly of children, have been rife in Poland and Russia at least since 1991. The buyers are supposed to be rich Arabs. Nancy Scheper-Hughes, an anthropologist at the University of California at Berkeley and co-founder of Organs Watch, a research and documentation center, is also a member and co-author of the Bellagio Task Force Report on Transplantation, Bodily Integrity and the International Traffic in Organs. In a report presented in June 2001 to the House Subcommittee on International Operations and Human Rights, she substantiated at least the nationality of the alleged buyers, though not the urban legends regarding organ theft: "In the Middle East residents of the Gulf States (Kuwait, Saudi Arabia, and Oman) have for many years traveled to India, the Philippines, and to Eastern Europe to purchase kidneys made scarce locally due to local fundamentalist Islamic teachings that allow organ transplantation (to save a life), but prohibit organ harvesting from brain-dead bodies. Meanwhile, hundreds of kidney patients from Israel, which has its own well -developed, but under-used transplantation centers (due to ultra-orthodox Jewish reservations about brain death) travel in 'transplant tourist' junkets to Turkey, Moldova, Romania where desperate kidney sellers can be found, and to Russia where an excess of lucrative cadaveric organs are produced due to lax standards for designating brain death, and to South Africa where the amenities in transplantation clinics in private hospitals can resemble four star hotels. We found in many countries - from Brazil and Argentina to India, Russia, Romania, Turkey to South Africa and parts of the United States - a kind of 'apartheid medicine' that divides the world into two distinctly different populations of 'organs supplies' and 'organs receivers'." Russia, together with Estonia, China and Iraq, is, indeed, a major harvesting and trading centre. International news agencies described, two years ago, how a grandmother in Ryazan tried to sell her grandchild to a mediator. The boy was to be smuggled to the West and there dismembered for his organs. The uncle, who assisted in the matter, was supposed to collect $70,000 - a fortune in Russian terms. When confronted by the European Union on this issue, Russia responded that it lacks the resources required to monitor organ donations. The Italian magazine, Happy Web, reports that organ trading has taken to the Internet. A simple query on the Google search engine yields thousands of Web sites purporting to sell various body parts - mostly kidneys - for up to $125,000. The sellers are Russian, Moldovan, Ukrainian and Romanian. Scheper-Hughes, an avid opponent of legalizing any form of trade in organs, says that "in general, the movement and flow of living donor organs - mostly kidneys - is from South to North, from poor to rich, from black and brown to white, and from female to male bodies". Yet, this summer, bowing to reality, the American Medical Association commissioned a study to examine the effects of paying for cadaveric organs would have on the current shortage. The 1984 National Organ Transplant Act that forbids such payments is also under attack. Bills to amend it were submitted recently by several Congressmen. These are steps in the right direction. Organ trafficking is the outcome of the international ban on organ sales and live donor organs. But wherever there is demand there is a market. Excruciating poverty of potential donors, lengthening patient waiting lists and the better quality of organs harvested from live people make organ sales an irresistible proposition. The medical professions and authorities everywhere would do better to legalize and regulate the trade rather than transform it into a form of organized crime. The denizens of Moldova would surely appreciate it. |
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