A Route to Value Creation: Cut Out Unnecessary Middle Men

Rentals for food stalls in Singapore are high. This comes as no surprise when rental to stall holders is done by real estate companies who have won government tenders to run a food centres. To quote an article reposted at the HardwareZone forum: (I can't find the original.)

Recall the fiasco last year, after the Housing Board put up a tender for a market and food centre to be wholly operated by a private operator in Sengkang. This was a pilot project following calls from HDB flat dwellers for wet markets and hawker centres to be built. Renaissance Properties, a subsidiary of foodcourt chain Kopitiam, beat 24 others with the highest bid to build and run the centre at $500,100 a month. That bid, however, translated into rents as high as $6,000 per stall, which is more than double the average rent for a stall in an NEA-run centre. As a result, stallholders charged about 30 per cent more for their cooked food than stalls elsewhere. Residents complained, or stayed away. Business was poor and some stalls were forced to close. ... Throughout, hawker stall rents have been kept moderately low, as an incentive for hawkers to price their food affordably. About 42 per cent of stallholders in NEA-run centres pay subsidised rent of between $160 and $320 per month. These are either hawkers who were relocated from street stalls, or their immediate family members. The other stalls are tendered out for between $300 and $4,900 per month. This rental is based on a valuer's assessment, taking into account stall size, location and the prevailing economic climate.

The contrast is stark. Before delving into the underlying economics, consider the following exchange that occurred in Parliament last year. In March 2010, then Hougang MP Low Thia Khiang argued in Parliament that competitive bidding for land to build these centres might result in high prices for consumers. Then Senior Minister of State for National Development Grace Fu disagreed. She said that private operators need to ensure that what is sold is affordable and relevant to the needs of residents, and that it would be presumptuous to say that a market which is operated by a private operator would lead to high prices.

With respect to her station, she is wrong. Basic undergraduate level economics would inform one that the commercial operator would attempt to raise rents as high as possible while making the rental transaction feasible with respect to the stallholder's participation constraint. Stallholders will participate in the rental transaction as long as they are able to make a living at the store and will raise prices if necessary to do so. This contention can be supported empirically. Kopitiam is known to attempt to estimate revenues of their tenants and raise rentals for the stalls that are doing well. It would be unsurprising if other landlords do the same.

(Naturally, if a stallholder expects to be able to make a better living at another location with a different rental, he will. However, when NEA-run stalls are not available, stallholders have to turn to commercial landlords, who have no incentive to lower rentals as they know the market can sustain their asking price. )

High rentals and raising rentals for successful stalls are a mechanism landlords use to transfer the economic value generated by stallholders to them. This strikes me as unfair. Without commenting further on equity between landlord and stallholder, I'd like to point the reader to the obvious negative externality that the economics leads to: higher prices, which reduce value for Singaporeans. The fact of the matter is, both theory and empirical evidence point to private profit seeking operators causing higher prices. The onus is thus on SMOS Fu to show that they do not.

On a more general note, this highlights a more general problem where the government enables middlemen to extract economic value from the primary value generators while generating little value themselves. In certain areas, middlemen do generate value. For instance, linking borrowers to savers is an economically valuable role performed by banks.

The government's justification for outsourcing tasks like management of food centres is that it does not want public service manpower performing non-core tasks. The government should bear in mind that this should not be done at the expense of value for the public.

It is axiomatic that commercial entities will not take on projects if good profits cannot be made. This profit has to come from somewhere. The government should keep this in mind when divesting operations. Where middlemen are unnecessary they should be cut out, otherwise they will extract value from the end-user (the public). In such cases, the public service does the people no service. Presently, value can be recaptured for the public (and value generators) by rolling back divestments that destroy value for Singaporeans.