Jaké reformy a proč (204) Wawrosz: Barriers

28. srpen 2014 | 08.00 |

Následující příspěvk byl připraven na mezinárodní konferenci v Turíně a byl zde též přednesen. Obsahuje několik nových prvků oproti materiálům, které byly doposud v rámci diskuse zaměřené na přípravu pracovní části 17. ročníku konference Lidský capital a investice do vzdělání předneseny. Uveřejňuji jej na několik pokračování. Toto je pátý z nich:

Transferred price and the sector of productive services as the key preconditions to smart, sustainable, and inclusive growth V.

Petr Wawrosz, Radim Valenčík

8. Discussion: Barriers to applying the transferred price mechanism and their elimination

Generally speaking, the necessary precondition to attaining smart, sustainable, and inclusive growth is the development of the productive services sector (as we defined the sector), whereas the way for ensuring this sector becomes the dominant economic sector is to allow the payment for services offered by the sector through the transferred price mechanism. If this is the case, why do not various entities operating within the sector start using the transferred price mechanism on their own? After all, the implementation of the mechanism is an innovation. In case the given innovation is prospective, individual entities should be motivated to use it. Why is it not the case? Standard objections to the transferred price mechanism are roughly as follows:

1. Effects generated by productive service customers will be reflected in their earnings in a long period of time. This weakens the ties between the services and the relevant earnings. Moreover, in case of a prolonged repayment of the given debt of the customer to the provider of productive services, the provider of such services will recover its costs and generate its profit a long time after the provision thereof. Immediate benefits are not clear; providers are exposed to a number of risks (they may lose client's contacts, have problems with corroborating the amount of earnings – i.e. whether a client is/is not required to pay, etc.). All this causes the providers of productive services to opt for standard forms of financing their activities (directly or in the near future).

2. The amount of client's earnings results from a number of factors. The fact a client was a customer of a productive service, contributes to the amount; however, it is not the only factor. It is difficult to estimate the impact of each factor, including the productive services, in advance. The impact of productive services may easily be overestimated or underestimated, which will be reflected in the transferred price parameters (contract duration, payment amount, minimum income amount – with clients not paying anything if the threshold is not reached, definition of the amount, from which clients make payments, etc.). Clients, for whom the impact of productive services was overestimated, will pay too much, thereby reducing their interest in productive services. On the other hand, clients, for whom the impact of productive services was underestimated, will pay too little, with the productive services providers not being able to cover their costs. Therefore, the easiest way is for clients to pay right away. In this case, the price may be determined based on the costs associated with the service, which at least reduces the risk of the service providers.

3. In case the productive services customers generate higher earnings in the future, and such increase is not related to the productive services, it seems unfair for those customers to pay anything from the given earnings to the service providers. Customers may try to conceal the given earnings or to ensure their payments are made in a way that prevents the need to pay the relevant share to service providers. This is associated with high transaction costs. Some customers may not even accept the higher earnings, including a situation, where they do not start performing activities that are directly associated with higher earnings. All this has negative microeconomic and macroeconomic implications, including an impact on economic growth.

4. Future repayments require high-quality monitoring system to limit the motivation of the productive services customers to hide their earnings. Moreover, it is necessary to ensure an effective debt collection system in respect of the providers' receivables from their customers. All this is difficult and costly. It is not clear whether the costs associated with the aforementioned would not outweigh the benefits.

Some objections may also be ideological. Let us at least mention two of those:

5. The application of the transferred price would result in an increased role of the market in areas that are traditionally viewed as areas ensuring public goods, providing positive externalities that contribute to the socialization of people, ensure interpersonal solidarity, raise individuals to citizenship, their involvement within the society, etc. This increased role of the market will lead to further moral devastation of the given segments, which have already been stigmatized by substantial commercialization and cease to serve their original purpose. As a result of such commercialization, some entities are already unable to consume public goods and goods and services with positive externalities, because of the barriers arising from the commercialization. Further promotion of the given market role will result in a rising number of such people.

6. The proposed model works with the idea that people are able to think long-term and can be motivated by long-term expectations. This is not the case in reality. Most people prefer immediate benefits to long-term ones. After all, even economic theory (e.g. Perloff 2008) clearly states that the value of present goods and services is higher than the value of future goods and services. It is difficult for people to image all the potential benefits of investments in their human and social capital. The effect of such investments is too long to be comprehensible for people.

We believe that most objections may be resolved - both the practical ones (points 1 through 4 of this Chapter) and the more or less ideological ones (pointns 5 through 6 of this Chapter). It is obviously true that customers will only start repaying the costs associated with the provision of productive services after some period of time and may be repaying for a relatively long period of time. However, there are other areas, where investments generate returns after the completion of the given investments, with a longer period of time from the moment they start to generate returns until the full settlement of all investment costs (including opportunity cost). There are various experiences with long-term repayments and mechanisms for addressing them. With regard to an objection that debtors usually have some assets that may be pledged in favor of their creditors in case of these forms of investments (as mentioned above in Chapter 4) and that this is not true for investments in human capital, we can answer that even though it is not possible to pledge the human capital of a debtor (borrower), it does not mean that a debtor does not have or will not acquire after the conclusion of the transferred price contract other assets that could be pledged in favor of the creditor. The method of monitoring and other issues relating to the debtor's earnings may also be addressed in a repayment contract. With regard to the contract parameters aimed at ensuring that debtors do not pay either too much or too little, as well as potential repayments from earnings that do not result from investments in human capital, it is safe to assume that the invention of people will seek answers to the given issues. Realistically speaking, we can assume that the transferred price principle will start evolving gradually. For example, the providers of productive services will ask for a partial payment in the standard manner – i.e. at the moment the services are provided, whereas the remaining amount will be paid in the form of transferred price. The providers and customers will gradually learn how to valuate effects of the given service, distinguish the effects resulting/not resulting from the given service, and this will be reflected in the contract parameters.

The ideological objections may also be addressed. With regard to the fourth objection relating to the expansion of the market to areas previously reserved for the public sector, it applies that the role of the public sector is to eliminate imperfections of the market mechanism and provide goods and services the market cannot provide, or provides them in an non-optimal manner (produces more/less than the market optimum). The public sector is not set down forever. If, as a result of human invention, it is possible to expand the market to areas that were previously associated with market failures, if it is possible to eliminate or mitigate such market failures, then there is nothing wrong about this. After all, the market is gaining ground in other areas that were previously viewed as the public sector domain, whereas such progress is possible as a result of human invention. The financing of highway construction, previously viewed as the public goods, in the form of toll collection or public private partnership projects is a good example. Logically, even the area of productive services need not be predominantly or largely ensured by the public sector, but they may also be provided on the basis of the market mechanism.

With regard to the fifth objection that the nature of the transferred price promotes the tendency to long-term thinking of people: People react to incentives and in case such incentives (also include the transferred price) motivate them to long-term thinking they will start to act in such manner (or at least some of them). The long-term thinking is also associated with an attribute of responsibility – people, who tend to think in a long-term horizon, do not consider solely immediate (or short-term) effects of their thinking that may have negative consequences in the long run, but they also take into account wider implications of their actions. The fact that the transferred price works with a long-term horizon is not its flaw, but actually its benefit. We may, at the same time, express a hypothesis that our current global society (i.e. not sometimes in the future, but in the present) needs to extend the time horizon we take into account in our decision-making process. We need this to learn, from an early age, how to project a lifelong path of professional fulfillment and anything that is associated with it. The transferred price principle thus comprises not only a rational element, but also an ethical one. In this case, the ethical element is not an external precondition, but something that originates and will increase in importance proportionally to the increasing role of productive services. In other words: The ethical dimension of the problem area is not exogenous, but rather endogenous element. In terms of the game theory, the following applies: The ethical dimension is not a mere precondition to the game, but mainly its outcome[11].

Therefore, if the above mentioned and usually given objections to the transferred price application are not the most important ones, which in fact are? We believe it is the currently limited competition in many parts of the sector of productive services. Areas such as university education, healthcare, spa sector, etc. are subject to strict regulation, with barriers to enter these sectors. Let us, for now, disregard the fact that some regulation makes sense to prevent risks to life or health of customers within the sector, to ensure at least minimum quality of the offered services. The public choice theory (e.g. Buchanan and Tullock 1999) points out that regulation may also serve in favor of the regulated entity – it may be set up in a way that limits (and sometimes even eliminates) competition of the regulated entity[12]. In such case, the regulated entities do not have to make such efforts to generate their profits. Moreover, the existing system insufficiently discloses, whether the services provided by such entities in fact have the required quality. Since customers pay at the moment a service is provided (if they pay at all, i.e. unless the costs of providers of productive services are covered from public budgets), there is no feedback that would clearly reveal/disclose the quality. The existing system is beneficial for existing providers; the application of the transferred price principle – even to a limited extent – would impair such benefits – this is why they prevent it[13]. Economically speaking, many providers of productive services operate in oligopolistic segments with low competition. Barriers to market entry are significant – i.e. the providers' earnings and profits are guaranteed.

Some providers may introduce the transferred price principle, in spite of the above mentioned, and agree that customers would pay for the services using their future earnings. At first glance, it should be beneficial for the provider: customers do not have to pay right away, but payments are postponed until they have money or until it is clear, whether the provision of the services was in fact meaningful, as appropriate. However, if this provider operates within a regulated industry, where some providers receive state support and are not forced to offer their services at market prices, it is disadvantaged. The services of such provider are mainly sought by clients, who are not – for any reason – eligible for the state-subsidized services. This usually involves high-risk clients. The example of the company My Rich Uncle mentioned in Chapter 5 is quite expressive. It clearly shows why most providers of productive services do not apply the transferred price principle. Their risk would increase, similarly as the likelihood of bankruptcy.

We believe that current regulated systems also fail to stimulate long-term thinking, create barriers to monitoring the customers' earnings and to assessing the contribution of productive services to such earnings. In case the customers' earnings are at least partially, often even indirectly, regulated, it blurs the relationship of the income level and productive services. This relationship becomes unclear, in case there are significant redistributions within a society, where earnings of some people are withdrawn ex officio and attributed to others. In this case, the income level also depends on different factors than the quality and success of productive services. Existing states, where the share of taxes or public expenditure in GDP, as appropriate, often exceeds 40%, may be described as societies with significant redistribution. This is only the visible part of redistribution. Further redistribution takes place, as some people have various privileges (e.g. are able to meet terms and conditions for receiving investment incentives, financial incentives for doing business in various segments) and other people do not. Both the existence and nonexistence of such privileges affects the performance and consequently remuneration of individual people.

In general, regulations prevent qualified estimates in respect of future development of earnings for a person that has used some productive services. As a result of the regulation, earnings may greatly depend on the regulation parameters and not on the quality of such productive service. Moreover, regulation may change – they reflect political cycles and other aspects of public choice[14]. Therefore, even if earnings of a person / recipient of productive services are, due to regulation, currently at a level that makes it possible to make payments to the service provider, this may not be the case after potential regulatory change. We believe the current environment is too risky, erratic, and unstable for the application of transferred price. For this reason, the given method of financing is only applied minimally. However, it results in a lower involvement of providers of productive services in the quality of such services as well as the fact that there are some people, who cannot pay for the services directly due to their existing budget constraints and will not ultimately purchase them. It further leads to insufficient level of economic growth, whereas such growth does not meet the required parameters to be referred to as smart, sustainable, and inclusive growth.

Naturally, we cannot rule out that the financing of productive services through the transferred price principle will win competition even in present condition and that the sector of productive services will actually start having a dominant role within individual countries' economies (expressed as a share of the sector in GDP, for example). However, unless the barriers to entry into the markets of productive services are reduced, such development will be difficult and subject to a longer period of time. Moreover, the principle may also be applied through undesired actions, where the current sources of growth are exhausted and where entities, whose income declines as a result of such exhaustion, will start to protest and perform other undesired actions. Therefore, we believe it is already worthwhile to eliminate various barriers to entry into markets of productive services. This is the only way we can, in our view, at least partially meet the goals of the Europe 2020 Strategy, i.e. delivering growth that is smart, sustainable, and inclusive.

[11] We must underline that, in our view, the given fact (The ethical dimension of the problem area is not exogenous, but rather endogenous element. The ethical dimension is not a mere precondition to the game, but mainly its outcome.) generally applies to all forms of human behavior. Therefore, it is not specific to transferred price. Detailed analysis exceeds the scope of this paper. For details, see Graafland (2007), for example.

[12] In this context, we should recall the conclusion of the public choice theory (Stigler 1971) that regulated entities are often able to gain control of the regulator and set up regulation to reflect their own interests.

[13] For instance public universities in the Czech Republic, whose financing heavily depends on public budget, opposed a suggestion to establish deferred tuition although it could increase their revenue, and tuition was not established. The tuition could assist in revealing the quality of the public universities' services and such revelation was not in the interest of public universities. For example, see Wawrosz and Heissler (2012) for details. 

[14] See e.g. Sobel et al (2001) for details.


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