[Free Speech] A Mandatory Supply Price Linkage System Is Not the Only Answer

Although plans have been finalized to pilot the delivery price indexation system—a long-standing wish of the small and medium-sized business community—starting this month, controversy over the policy’s effectiveness has not gone away. Nevertheless, amid damage to global supply chains caused by COVID-19 and high inflation stemming from the economic shock, calls from SMEs for the introduction of this system are growing louder.

The “delivery price indexation system” refers to a system for adjusting delivery prices so that changes in the prices of raw materials and the like are reflected in delivery prices. At first glance, it may seem like a utopian policy that prevents SMEs from having to bear alone the burden caused by rising raw material prices. However, the delivery price indexation system carries considerable side effects in the long term.

First and foremost, there is concern that market principles will be undermined by policy authorities’ intervention in price-setting. Since the delivery price indexation system has the characteristic of legally forcing delivery prices to rise by the amount of the increase in raw material prices, it can prevent prime contractors from unilaterally abusing a dominant market position. At the same time, however, it also weakens the competitive effect of subcontractors.

That is why policy authorities’ intervention in price-setting must be kept to the minimum necessary and used only as a last resort. In other words, intervention should occur only when it is impossible to improve a competition-restricting market through other means, and even then, excessive state intervention must not be allowed.

From that standpoint, the delivery price indexation system does not satisfy the condition of being the last and minimal improvement to the existing delivery price adjustment system. This is because legally mandated, uniform price-setting—without considering firms’ characteristics at the delivery stage or supply and demand conditions in the relevant market—may be seen as the result of excessive state intervention, one that comes closer to fundamentally blocking competition than to improving competitive conditions.

In addition, there are concerns about rising transaction costs in responding to raw material price volatility. If SMEs that qualify as subcontractors raise delivery prices under the delivery price indexation system, it cannot be ruled out that the increase will be passed on to consumers.

There is also controversy over reverse discrimination against foreign firms. Capital and investment naturally flow to the most efficient places. If government price controls become more heavy-handed, prime contractors will be more likely to outsource to foreign firms that involve relatively lower costs. That would end up causing even greater losses for domestic partner companies.

Ultimately, introducing the delivery price indexation system would instead make the domestic industrial ecosystem more vulnerable. The fact that government intervention in market prices can end up harming the very parties it seeks to protect is no exception in the case of the delivery price indexation system.

Concerns about undermining the possibility of price or quality competition among suppliers and about hampering technological innovation also cannot be avoided. If prices are not left to the market participants involved in the transaction and the government intervenes directly, innovative firms cannot grow. From the standpoint of suppliers, if the indexation system is implemented, incentives to reduce costs will decline, thereby hindering innovation among SMEs. If the government guarantees an appropriate profit, who would seek to cut costs and think seriously about innovation? This could ultimately encourage cartel formation among suppliers, resulting in an outcome that actually creates opportunities to move farther away from fair trade.

It cannot be denied that the sharp rise in raw material prices due to supply chain disruptions caused by the COVID shock and the war in Ukraine has inflicted great pain on SMEs. It is also understandable that SMEs, which are relatively disadvantaged within the industrial ecosystem, would find it difficult to demand higher delivery prices. However, if for such reasons the government rashly legislates and uniformly forces “appropriate prices,” various side effects will emerge, and the policy’s effectiveness will be even less likely.

The answer may lie not in government price intervention or coercion through制度, but in having prime contractors and subcontractors draft a “standard subcontract agreement” by mutual consent and granting benefits to firms that voluntarily comply with it.

The Fair Trade Commission is already encouraging the use of standard subcontract agreements by preparing them and providing incentives under Article 3-2 of the Subcontracting Act. However, it is true that their effectiveness has been limited because they are not mandatory, and because there is an atmosphere of concern that applying for mediation could lead to a cutoff in transactions for relatively weaker firms. In fact, since the consultative system was introduced in 2009, there has not been a single case of an application for delivery price adjustment through a cooperative. In that respect, it is understandable that support for introducing the delivery price indexation system has been intensifying.

Conversely, this also means that the incentives have not been attractive enough. From the subcontractor’s standpoint, there is no reason at all to use a standard subcontract agreement while enduring soaring delivery prices. The reason is fear of retaliation from the prime contractor. If so, why not revise the system so that prime contractors are induced to draft standard subcontract agreements first? Introducing a system whose side effects are plainly foreseeable before even revising the existing system is proceeding in the wrong order.

Now is the time to introduce a system one step more advanced than the existing one, which imposes unfair treatment only on subcontractors. If major contractors that voluntarily implement a cost indexation system were given exceptional support such as tax incentives, positive effects could be expected. Rather than a “mandatory law,” the answer lies closer to “voluntary efforts for mutual prosperity.”

Yoojung Shin, Intern Researcher, Center for Free Enterprise (CFE)

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Original title: [자유발언대] 납품단가 연동제, 강제만이 해답이 아니다

Author: Yu-jeong Shin

Date: 2022-09-16

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=free_opinion&pn=8&idx=24964