Monday, October 12, 2015

Competition does have its drawbacks

Competition is billed by economists as a wonderful thing, the invisible restrainer of a capitalist economy and essential to ensuring consumers get a good deal.

But many economists aren't as conscious as they should be that competition has costs as well as benefits.

It's true, of course, that monopoly is usually a terrible thing, allowing arrogant, inflexible behaviour on the part of producers, with little pressure on them to keep prices down or to provide much choice. Dealing with government departments shows you what monopolies are like.

Economists tend to assume the more competition the better and that customers can never get too much choice. But this shows how – despite their loud protestations to the contrary – their thinking is excessively influenced by their most basic, least realistic model of "perfect competition".

Psychological experiments show that when shoppers face too much choice, they tend to avoid making a decision. That's because the information they need to make informed choices isn't freely available and because the human mind hasn't evolved to be good at choosing between more than two items with differing characteristics.

Many real-world markets are characterised by oligopoly: a few large firms accounting for most of the sales. Oligopolies make economic sense because they're needed to fully exploit economies of scale (which are assumed away under perfect competition). So, in reality, competition and scale economies are in conflict.

In oligopolies and even in markets with a relatively large number of producers, competition is blunted by product differentiation, much of which is cosmetic. As with most advertising, product differentiation is intended to induce consumers to make decisions on an emotional rather than rational basis.

Phoney differentiation is also intended to frustrate rational comparison. It's not by chance that it's almost impossible to compare mobile phone contracts.

When economists speak of competition, they're usually thinking of competition on price. But though oligopolists watch their competitors like hawks, they much prefer to avoid price competition, competing rather via advertising, marketing, packaging and other differentiation.

Mackay's Law of competition states that the key to competition is to focus on the customer, not your competitor. But this is what oligopolists don't do.

In the real world – including the media – competitor-oriented competition is rife. This robs customers of genuine choice. It's a form of risk aversion: if I do the same as my competitor, I minimise the risk of him beating me.

It's what, in Harold Hotelling's classic example, prompts two ice-cream sellers to be back-to-back in the middle of the beach, regardless of whether some other positioning would serve customers better. It explains why business economists' forecasts tend to cluster, usually around the official forecast.

In his book The Darwin Economy, Robert Frank, of Cornell University, argues that lefties tend to see inadequate competition as the most prevalent form of market failure, whereas it's actually "collective action problems".

A collective action problem arises when the players in a market realise they're doing something mutually destructive, but no one's game to stop doing it for fear of being creamed by their competitors.

Usually in commercial markets the only answer is for the government to intervene and impose a solution on all players; for which they're grateful.

However, that's no help to our political parties, which have got themselves locked in a game of ever-declining standards of behaviour they don't know how to escape from. It's collective action problems that make it so easy for the politicians to manipulate the media.

The advocates of federalism believe it's good to have the states free to be different and competing against each other. In reality, the competition is mainly negative. The states compete to attract foreign investors with special tax concessions and the foreigners play them off against each other.

In the early 1970s, the McMahon government transferred its payroll tax to the states to give them the "growth tax" they needed to cover their growing spending. In the decades since then, they've done little but compete with the others by raising their tax-free thresholds and cutting their rates.

The huge increase in federal grants to private schools over recent decades was justified as increasing parents' choice and imposing competitive pressure on public schools. There's little evidence it's worked, nor much even that it's held down private school fees.

Similarly, Julia Gillard's My School website, with all its information about the academic performance of particular schools, intended to increase competition between them, has failed to produce any increase in the proportion of students achieving national minimum standards in reading, writing and numeracy over the five years to 2014.

Depending on circumstances, competition can make things better or worse – or little different.