Showing posts with label oligopoly. Show all posts
Showing posts with label oligopoly. Show all posts

Friday, February 9, 2024

You can (partly) blame cost-of-living crisis on greedy businesses

The nation’s economists and economist-run authorities such as the Reserve Bank have not covered themselves in glory in the present inflationary episode. They’ve shown a lack of intellectual rigor, an unwillingness to re-examine their long-held views, and a lack of compassion for the many ordinary families who, in the Reserve’s zeal to fix inflation the blunt way, have been squeezed till their pips squeak.

There’s nothing new about surges of inflation. Often in the past they’ve been caused by excessive wage growth, where economists have been free with their condemnation of greedy workers. But this one came at a time when wage growth was weak and barely keeping up with prices.

What economists in other countries wondered was whether, this time, excessive growth in profits might be part of the story. Separate research by the Organisation for Economic Co-operation and Development, the International Monetary Fund, the Bank for International Settlements, the European Commission, the European Central Bank, the US Federal Reserve and the Bank of England suggested there was some truth to the idea.

But if the Reserve or our Treasury shared that curiosity, there’s been little sign of it. Rather, when the Australia Institute replicated the European Central Bank’s methodology with Australian data and found profit growth did help explain our inflation rate, the Reserve sought to refute it with a dodgy graph, while Treasury dismissed it as “misleading” and “flawed”.

One leading economist who has been on the ball, however, is Professor Allan Fels, a former chair of the Australian Competition and Consumer Commission, whose experience of competition and pricing issues goes back to the year before I became a journalist.

In his report this week on price gouging and unfair pricing practices, commissioned by the Australian Council of Trade Unions, he concluded that “business pricing has added significantly to inflation in recent times”.

Fels says his report is “fully independent” of the ACTU, which did not try to influence him. Considering his authority in this area, I have no trouble believing it.

“ ‘Profit push’ or ‘sellers’ inflation’ has occurred against a background of high corporate concentration and is reflected in the surge of corporate profits and the rise in the profit share of gross domestic product,” he finds.

“Claims that the rise in profit share in Australia is explained by mining do not hold up. The profit share excluding mining has risen and [in any case,] energy and other prices associated with mining have been a very significant contributor to Australian inflation,” he says.

Fels says there has been much discussion about inflation and its causes – including monetary policy and fiscal policy, international factors, wages, supply chain disruption and war, but “hardly any discussion that looks at actual prices charged to consumers, the processes by which they are set, the profit margins and their possible contribution to inflation”.

His underlying message is that there are too many industries in Australia which are dominated by just a few huge companies – too many “oligopolies” – which limits competition and gives those companies the ability to influence the prices they can charge.

“Not only are many consumers overcharged continuously, but ‘profit push’ pricing has added significantly to inflation in recent times,” he says, nominating specifically supermarkets, banks, airlines and providers of electricity.

Fels says, “some of Australia’s largest businesses, often [those selling such necessities that customers aren’t much deterred by price rises], are maintaining or increasing margins in response to the global inflationary episode”.

He identifies eight “exploitative business pricing practices” – tricks – that enable the extraction of extra dollars from consumers in a way that wouldn’t be possible in markets that were competitive, properly informed, and that enabled overcharged customers to switch easily from one business to another.

First, “loyalty taxes” set initial prices low and then sharply increase them in later years when customers can’t easily detect, question, or renegotiate them, and where the “transaction costs” of changing to another firm are high. This trick can be found in banking, insurance, electricity and gas.

Second, “loyalty schemes” are often low-cost means of retaining and exploiting consumers by providing them with low-value rewards of dubious benefit.

Third, “drip pricing” occurs when firms advertise only part of a product’s price and reveal other costs as the customer continues through the purchasing process. This trick is spreading in relation to airlines, accommodation, entertainment, pre-paid phone charges, credit cards and other things.

Fourth, “excuse-flation” occurs when general inflation provides camouflage for businesses to raise prices without justification. This has been more prevalent recently. As the inflation rate starts falling, excessive inflation expectations and further cost increases can be built in to prices.

Fifth, “confusion pricing” involves confusing customers with myriad complex price structures and plans, making it difficult to compare prices and so dulling price competition. This is occurring increasingly in mobile phone plans and financial or maintenance service contracts.

Sixth, asymmetric or “rockets and feathers” pricing is a big deal now the rate of inflation is falling. When a firm’s costs rise, prices go up like a rocket; when its costs fall, prices drift down slowly like a feather.

Fels says this trick can be very profitable for businesses. The banks have long been guilty of this stunt, yet I can’t remember a Reserve Bank governor ever calling it out.

Seventh, “algorithmic pricing” is where firms use algorithms to change prices automatically in response to what their competitors are doing. Fels wonders whether this reduces price competition and is analogous to the way now-illegal cartel pricing worked.

Finally, “price discrimination” involves charging different customers different prices for the same product, according to what the firm deduces a particular customer is “willing to pay”. The less competition firms face, the easier it is for them to play this game.

That so few economists and econocrats have been willing to think about these issues doesn’t speak well of their profession’s integrity. If they won’t speak out about businesses’ failings, why should we trust what they do tell us?

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Friday, July 14, 2023

Less competition reduces the power of interest rates to cut inflation

The ground has been shifting under the feet of the world’s central bankers, including our own Dr Philip Lowe, the outgoing chief of the RBA. This has weakened the power of higher interest rates to get inflation down.

Like all economists, central bankers believe their theory – their “model” – gives them great understanding of how the economy works and what they have to do to keep inflation low and employment high.

They know, for instance, that inflation – rising prices – occurs when the demand for goods and services exceeds the economy’s ability to supply those goods and services. So they can use an increase in interest rates to discourage businesses and households from spending so much.

This will reduce the demand for goods and services, bringing it into alignment with supply and so stop it causing prices to rise so quickly. It will also slow the rate at which the economy’s growing, of course.

But, with a bit of care, they won’t need to push interest rates so high the economy goes into “recession”, when demand (spending) becomes so weak that the economy gets smaller, causing some businesses to go bust and many workers to lose their jobs.

This theorising has worked reasonably well for many years, leading central bankers to be confident they know how to fix the present surge in inflation.

But the economy keeps changing, particularly as we keep using advances in technology to improve the range of goods and services we produce, and the way we produce them.

One consequence of our businesses’ unending pursuit of labour-saving technology – more of the work being done by machines and less by humans – has not been fewer jobs, but bigger factories and businesses.

As in all the rich economies, many industries are now dominated by just a few huge companies. In our case, we’re down to just four big banks, three big power companies, three big phone companies, two airlines and two supermarket chains. And that’s before you get the handful of giants dominating the rich world’s internet hardware, software and platforms.

Trouble is, when just a few firms dominate an industry, they gain “market power” – the power to hold their prices well above their costs; to increase their “markup”, as economists say.

The size of markups is a measure of the degree of competition in an industry. When competition between firms is strong, markups are low. When competition is weak, markups are high.

There is much empirical evidence that industries in the rich countries have become more concentrated over time, and markups have risen. And, as I’ve written before, Australia’s no exception to this trend.

In economics, “monopoly” means just one seller. “Monopsony” means just one buyer. So, when a firm has a degree of monopoly power, it can overcharge its customers. When a firm has a degree of monopsony power – when workers don’t have many employers to pick from – it can underpay its workers.

Researchers have found much evidence of labour-market power. And again, I’ve written before about the evidence this, too, is happening in Australia.

But this week, at the annual Australian Conference of Economists, federal Competition Minister Andrew Leigh, himself a former economics professor, drew attention to two recent International Monetary Fund research papers suggesting that a lack of competition is reducing the effectiveness of monetary policy – the manipulation of interest rates – in influencing inflation.

The first paper, by Romain Duval and colleagues, uses American data and data from 14 advanced economies to find that, compared with low-markup firms, high-markup firms are less likely to respond to changes in interest rates. The level of their sales changes less, as do their decisions about future investment in production capacity.

So, fat markups mean companies are less likely to change their behaviour. They’re not likely to cut their investment spending, for example.

This means more of the pressure to respond to higher rates will fall on households with big mortgages, but also on firms with low markups.

The second paper, by Anastasia Burya and colleagues, uses online job ads from across the United States to find that in regions where firms have a lot of labour-market power – that is, where workers don’t have much choice of where to work – those firms can hire workers without having to offer higher wages to attract the people they need.

This is the opposite of what standard theory predicts. It’s bad news for workers, who could have expected strong demand for labour to push up wages.

But another way to look at it is that, where big firms have labour-market power, there’s little relationship between employment and the change in wages. If so, conventional calculations of the “non-accelerating-inflation rate of unemployment” – the lowest point to which unemployment can fall without causing wages to take off – will give wrong results, encouraging central banks to keep unemployment higher than it needs to be.

And at times when price inflation is too high, unemployment will have to rise by more than you’d expect to get the rate of inflation back down to where you want it. How do you bring about a bigger rise in unemployment? By increasing interest rates more than you expected you’d have to.

So, whether it’s inadequate competition in the markets for particular products, or inadequate competition in the market for workers’ labour, lack of competition makes monetary policy – moving interest rates – less effective than central bankers have assumed it to be.

The model of how markets work that central bankers (and most other economists) rely on assumes that the competition between firms – including the competition for workers – is intense.

In the real world, however, markets have increasingly become dominated by just a few huge firms, which has given them the power to keep prices higher than they should be, and wages lower than they should be.

Leigh, Minister for Competition, gets the last word: “If you care about central banks being able to do their jobs, then you should care about a competitive and dynamic economy.”

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Wednesday, March 29, 2023

Voters turn from the big parties, increasing political competition

John Howard is right to describe the NSW election result as a “conventional change of government”. An old and disfigured government was tossed out and the other side given a go. It’s common when a government’s been in power for a decade or more. But don’t let this convince you nothing’s changed about the way we vote.

What’s happening is that the longstanding two-party system of government is breaking down before our eyes. Years of bad behaviour by the Coalition and Labor are leading more people to vote for minor parties and independents.

This means it’s become rare for any government, state or federal, to be elected with a big majority. Majorities now tend to be narrow, and minority governments are common, particularly at state level.

The big two are always telling us a “hung parliament” would be a terrible thing, causing “chaos and confusion”. Not true. They say this because it would be a terrible thing for them, requiring them to do deals with people they hate, to get the numbers to govern.

The “crossbenchers” usually drive a hard bargain. NSW’s four-year, fixed-date elections were forced on Liberal premier Nick Greiner in 1991 by three independents. Julia Gillard’s short-lived carbon tax was forced on her by the Greens, when she fell short of a majority in 2010.

So weaker governments are bad for the major parties, but good for democracy and voters, who get more to choose from.

Why is any of this the business of an economics writer? Because the nature of competition between a few big players in a market – “oligopoly” – is a subject economists study. And two-party government has a lot in common with markets dominated by two huge companies – duopoly.

But first, a closer look at the latest election. The “landslide” to Labor is looking a fair bit less than it looked on Saturday night. Chris Minns hasn’t yet secured a majority, and if he does, it will be narrow. Why? Because so many people are voting for minor parties and independents. At this stage in the counting, 28 per cent of voters spurned the big two. This compares with almost 32 per cent at the federal election last May, where the big swing away from the Liberals gave Labor just a narrow majority.

In NSW, the Greens look to have retained their three seats in the lower house, with independents looking sure of eight seats, and probably more. One of the new independents was backed by teal money.

An American economist named Harold Hotelling is famous for talking about a beach with two ice-cream sellers. From the swimmers’ perspective, the best place for them would be one at the quarter-mark and the other at the three-quarter mark. This would minimise the distance anyone had to walk to get a cone.

But Hotelling figured that the two would end up back-to-back at the centre of the beach. Why? Because that was the way each could ensure the other got no more than half the “market share”.

The social psychologist Hugh Mackay says that the key to competition is to focus on the customer, not your competitor. That’s just what oligopolists and our political duopolists don’t do.

If there’s one thing most people don’t understand about politics it’s the way each big party obsesses about what the other side’s doing, and how it will react to what they do.

It was this that caused Anthony Albanese to go to last year’s election promising to do nothing that could offend anyone much. Promise to make needed but controversial changes and the other side launches a scare campaign. It’s only when politicians tell us how bad the other side’s policies would be that we’re tempted to believe them.

The two sides are always trying to “wedge” each other by announcing a bad but popular policy and hoping the other side will be silly enough to oppose it.

Trouble is, they rarely fall for it. They sidestep the wedge by supporting the policy. Which means both sides end up agreeing to do bad things. This is why Albanese agreed to the AUKUS pact sight unseen and, earlier, to stick with the stage three tax cut that’s biased against Labor voters.

This is where the minor parties come in, particularly those sharing the balance of power in the Senate. They can use their power to stop, or at least tone down, the bad policies the government of the day foolishly locked itself into.

Consider this. Last week Climate Change Minister Chris Bowen loudly vowed not to negotiate with the Greens over his “safeguard mechanism”. But by Monday, wiser heads had prevailed, and a deal was done, making the mechanism much more effective.

The big two each offer voters a policy package-deal not very different to the other one’s. Whichever package you pick will include policies you don’t like. But the minor party and independent “new entrants” to the political market give consumers a wider choice by forcing the big guys to “unbundle” their packages.

Sounds more like democracy’s supposed to be.

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Sunday, December 18, 2022

Hey RBA boomer, things have changed a lot since the 1970s

Sorry, but Reserve Bank governor Dr Philip Lowe’s call for ordinary Australians to make further sacrifice next year in his unfinished fight against “the scourge of inflation” doesn’t hold water. His crusade to save us all from a wage-price spiral is like Don Quixote tilting at windmills only he can see.

In one of his last speeches for the year, Lowe “highlighted the possibility of a wage-price spiral” in Australia. A lesson from the high inflation we experienced in the 1970s and ’80s is that “bringing inflation back down again after it becomes ingrained in people’s expectations is very costly and almost certainly involves a recession”.

He noted that this was a real risk in “a number of other advanced economies [which] are experiencing much faster rates of wages growth”.

But not to worry. “This is an area we are watching carefully.” The Reserve Bank board is “resolute in its determination to return inflation to target, and we will do what is necessary to achieve that”.

Oh. Really? Like the smartest of the business economists, I’ve been thinking that having raised the official interest rate by 3 percentage points in eight months, Lowe may have decided he’s done enough. But this tough-guy talk hints at more to come – maybe a lot more.

One thing I am pretty sure of, however. After the caning Lowe’s been given for saying repeatedly that he didn’t expect to be raising interest rates until 2024, when he does decide he has done enough, he won’t be saying so.

To leave his options open – and pacify the urgers in the financial markets who want him to do a lot more – he’ll say it’s just a pause to see how the medicine’s going down. And add something like “the board expects to increase interest rates further over the period ahead, but it is not on a pre-set course”.

One reason Lowe doesn’t have to raise rates as far as many overpaid money-market people imagine is that with real wages having fallen in recent years, and expected to keep falling, the nation’s employers are doing his job for him.

Raise mortgage interest rates or cut real wages – whichever way you do it, the result is to put the squeeze on households, to stop them spending as much (on the things the people who cut their wages are hoping to sell them – no, doesn’t make sense to me, either).

So, we’re back to Lowe’s professed fear of a wage-price spiral. The entire under-50 population must be wondering what such a thing could be. Lowe spelt it out while answering questions after his speech.

“The issue that many central banks have been worried about – and I include us in this – is [that] this period of high inflation will lead the workforce to say: ‘Well, inflation is high, I need compensation for that’.”

“And let’s say we all accepted the idea, which [has] a natural appeal: ‘inflation is 7 per cent, I should be compensated for that in my wages’. If that were to happen, what do you think inflation would be next year? Seven per cent, plus or minus.

“And then we’ve got to get compensated for that 7 per cent, and 7 per cent. . . This is what happened in the ’70s and ’80s and ... that turned out to be a disaster,” Lowe said.

“So I know it’s very difficult for people to accept the idea that wages don’t rise with inflation. And people are experiencing a decline in real wages. That’s tough. The alternative, though, is more difficult,” he added.

This is a reasonable description of how the wage-price spiral worked in the olden days. But as a plausible risk for today, it has two glaring weaknesses.

First, it assumes that if workers decide they want a 7 per cent pay rise, bosses have no choice but to hand it over. This is fantasy land.

The plain truth is that these days, workers lack the industrial muscle to force big pay rises on employers. The best-placed workers on enterprise agreements are getting rises of 3 to 4 per cent, but some are still getting rises in the twos.

The lowest-paid quarter of workers, dependent on award wage minimums, get their rises determined annually by the Fair Work Commission – but these are granted in retrospect, not prospect. This July, a handful of them got a rise of 5.2 per cent, but most got 4.6 per cent.

The bargaining power workers had in the ’70s has been reduced by more than four decades of globalisation, technological change and wage-fixing “reform”. In 1976, 52 per cent of workers were members of a union. Now it’s down to just 12.5 per cent.

Yet another reason a wage-price spiral couldn’t happen today is that most enterprise agreements run for three years. The system prohibits me from striking for a pay rise this year higher than the one I already agreed to two years ago.

The second respect in which Lowe’s fear of a wage-price spiral rising from the dead is silly is the assumption that if workers get a 7 per cent pay rise, businesses will automatically and easily put their prices up by 7 per cent. This makes sense arithmetically only if you think that wage costs constitute the whole of businesses’ costs. In truth, the Bureau of Statistics’ input-output tables say that economy-wide, wages account for only about a quarter of total input costs.

So, on average, a 7 per cent wage rise justifies a price rise of less than 2 per cent. Since business competitors would be paying much the same, you might think any firm that turned a 2 per cent cost increase into a 7 per cent price rise would be asking to be undercut by its competitors and lose its share of the market.

Of course, such an outrageous assault on the pockets of the industry’s customers would be possible if the industry was dominated by just a few big firms. They could – and have, and do – reach an unspoken agreement to each put their prices up by the same excessive amount.

It’s clear that Lowe knows a lot about how financial markets work, but not much about labour markets. But I find it hard to believe he could be so ill-informed as not to see the weaknesses in his wage-price spiral boogeyman.

The other possibility is that what’s really worrying him is a mass outbreak of oligopolistic pricing power. Getting that back under control really could take a recession.

Monetary policy (manipulating interest rates) is no cure for market power. The only answer is stronger competition policy and tougher policing by the Australian Competition and Consumer Commission. But neither the Reserve Bank nor Treasury has had much enthusiasm for this.

Much less controversial to blame inflation on greedy workers and tell the mums and dads it’s their duty to the nation to tighten their belts and lose their jobs until the problem’s solved.

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Friday, August 26, 2022

Don't expect great productivity if we give business an easy ride

An unwritten rule in the economic debate is that you can say whatever you like about the failures of governments – Labor or Liberal; federal or state – but you must never, ever criticise the performance of business. Maybe that’s one reason we’re getting so little productivity improvement these days.

One reason it’s unwise to criticise big business is that it’s got a lot of power and money. It can well defend itself but, in any case, but there’s never any shortage of experts happy to fly to its defence, in hope of a reward.

But the other reason is the pro-business bias built into the standard demand-and-supply, “neoclassical” model burnt into the brains of economists. It rests on the assumption that market economies are self-correcting – “equilibrating” - and so work best when you follow the maxim “laissez-faire” – leave things alone.

So if markets don’t seem to be going well, the likeliest explanation is that intervention by governments has stuffed them up. Business people always respond rationally to the incentives that governments create, so if what business is doing isn’t helpful, it must be the government’s fault.

In theory, economists know about the possibility of “market failure”, but many believe that, in practice, such failures are rare, or of little consequence.

All this explains why almost all discussion of our poor productivity performance assumes it must be something the government’s doing wrong, which needs “reforming”. You’ll see this mentality on display at next week’s jobs and skills summit.

Which is surprising when you remember that, for the most part, productivity improvement – producing more outputs of goods and services from the same or fewer inputs of raw materials, labour and physical capital – occurs inside the premises of businesses, big or small.

Fortunately, one person who understands this is the new assistant treasurer, Dr Andrew Leigh, a former economics professor, who this week used the Fred Gruen lecture at the Australian National University to outline recent Treasury research on the “dynamism” of Australian businesses – how good they are at improving their performance over time.

The news is not encouraging. One indicator of dynamism is job mobility. When workers switch from low-productivity to high-productivity firms, they earn a higher wage and make the economy more efficient.

The proportion of workers who started a new job in the past quarter fell from 8.7 per cent in the early 2000s to 7.3 per cent in the decade to the end of 2019.

Another indicator of dynamism is the “start-up rate” – the number of new companies being set up each year. It’s gone from 13 per cent in 2006 to 11 per cent in 2019.

Over the same period, the number of old companies closing fell from 10 per cent to 8 per cent. So our firms are living longer and getting older.

The neoclassical model assumes a high degree of competition between firms. It’s the pressure from competition that encourages firms to improve the quality of their products and offer an attractive price. It spurs firms to develop new products.

Competition encourages firms to think of new ways to produce their products, run their businesses and use their staff more effectively, Leigh says.

“In competitive industries, companies are forced to ask themselves what they need to do to win market share from their rivals. That might lead to more research and development, the importation of good ideas from overseas, or adopting clever approaches from other industries.

“Customers benefit from this, but so too does the whole economy. Competition creates the incentive for companies to boost productivity,” he says.

As Leigh notes, the opposite to competition, monopoly, is far less attractive. “Monopolists tend to charge higher prices and offer worse products and services. They might opt to cut back on research, preferring to invest in ‘moats’ to keep the competition out.

“If they have plenty of cash on hand, they might figure that, if a rival does emerge, they can simply buy them out and maintain their market dominance. Monopoly [economic] rents lead to higher profits – and higher prices.”

Taken literally, “monopoly” means just one seller, but economists use the word more broadly to refer to just a few big firms - “duopoly” or, more commonly, “oligopoly”.

One indicator of the degree of “market power” – aka pricing power – is how much of a market is controlled by a few big firms. At the start of this century, the market share of the largest four firms in an industry averaged 41 per cent. By 2018-19, it had risen to 43 per cent. So across the economy, from baby food to beer, the top four firms hold a high and growing share of the market.

And the problem’s even greater when you remember that the rival firms often have large shareholders in common. For instance, the largest shareholders of the Commonwealth Bank are Vanguard and Blackrock, which are also the largest shareholders of the three other big banks.

But the strongest sign of lack of competition is the size of a company’s “mark-up” – the price it charges for its product, relative to its marginal cost of production. In the textbook, these mark-ups are wafer thin.

Treasury estimates that the average mark-up increased by about 6 per cent over the 13 years to 2016-17. This fits with the trend in other rich economies. And the increase in mark-ups has occurred across entire industries, not just the market leaders.

It seems that rising market power has reduced the rate at which labour flows to its most productive use, which in turn has lowered the rate of growth in the productivity of labour by 0.1 percentage points a year, according to Leigh’s rough calculations.

If so, this would explain about a fifth of the slowdown in productivity improvement since 2012. Lax regulation of mergers and takeovers has allowed too many of our big businesses to get fat and lazy, even while raising their prices and profits. But don’t tell anyone I said so.

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Monday, February 24, 2020

Phone users have a reason to cheer ACCC's black eye

How much do you pay for your mobile phone contract – a lot or a little? Do you wish there was more price competition in a market dominated by three big companies, Telstra, Optus and Vodafone?

The Australian Competition and Consumer Commission has been stymied in its efforts to make that possibility more likely.

Last year the competition commission blocked a plan for Vodafone (one of the world’s biggest mobile phone companies) to "merge" with TPG (a mainly fixed-line phone and internet service provider) on the grounds that it could substantially lessen competition in the mobiles market.

Earlier this month the Federal Court overturned the commission’s ruling and allowed the merger to proceed – to much cheering from big business, which loves seeing the interfering competition regulator get a poke in the eye.

But phone users have nothing to cheer about. A chance to get more effective competition in the mobile phone market has been lost. Any threat of disruption to the comfortable life of the three-firm oligopoly – which already controls almost 90 per cent of the market – has been removed.

The competition commission thought the merger would do little to increase competition in the mobiles market, whereas allowing the smallest of the big-three oligopolists to take out the one outsider that could have threatened their cosy oligopoly – TPG – made it unlikely their cosy arrangement would ever be disrupted.

It thought this because, under the leadership of its swashbuckling chairman, David Teoh, TPG had turned itself into a company big enough to challenge Telstra and Optus in the internet provider market by acquiring various smaller providers and offering more competitive prices. And it had already spent $1.26 billion preparing to build a mobile network, before the government refused to let it partner with the Chinese-owned leader in 5G technology, Huawei.

Were the merger to be prevented, the commission believed, there was a good chance that TPG, with its record as a disrupter of markets, would revert to its plan to break into the mobile market, and do so by undercutting the incumbents’ prices.

The court rejected the competition regulator’s argument, primarily because it accepted Teoh’s assurance that he’d abandoned his plan to break into the mobiles market and wouldn’t return to it.

The court ruled that “it is not necessarily the number of competitors that are in the relevant market, but the quality of the competition that must be assessed. Further, it is not for the ACCC or this court to engineer a competitive outcome”.

Sorry, your honour, not sure what you mean. It’s certainly true that assessing the competitiveness of an oligopolistic market is more complicated than counting the number of dominant firms. The complexity comes in assessing the nature of the competition.

But what does it mean to “engineer” a competitive outcome? If it means the competition regulator and the court can’t do anything that would increase the likelihood of an industry being disrupted by a new and aggressive entrant, it’s telling us the law is biased in favour of maintaining the status quo and thus protecting the comfortable lives of the incumbents.

Does it mean the only views the authorities may hold about how the future may unfold for the industry must come from what the companies seeking permission to merge say about their intentions, not from the evidence economists have gathered about how oligopolists seek to compete in ways that maximise their profits and limit the benefit to their customers?

One of the main ways the rich countries have become rich is by firms’ continuous pursuit of economies of scale. The inevitable consequence, however, is that most of our markets have become dominated by a small number of huge firms with considerable power to influence the prices charged – especially if they reach an unspoken agreement to avoid competing on price.

The big question for public policy is how to ensure the gains from scale economies flow through to customers in lower prices and better service, rather than being retained as “super profit” in excess of the “normal profit” needed to cover the firm’s cost of capital and the risks it’s run. This is why economists have built up a great body of empirical knowledge about how oligopolists behave.

The court found that increasing the number of big players in the mobiles market from three to four (should the merger be blocked and TPG resume its plan to enter the market) would do little to increase competition, whereas allowing Vodafone to buy out the potential entrant and so become closer in size to its two rivals would improve competition.

Sorry, both conclusions run contrary to what the empirical evidence tells us was likely to happen. Remember, the chief tactic the world's digital megafirms have used to protect their pricing power is buying out small outfits looking like they could become a disrupter.
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Monday, November 11, 2019

Confessions of a pet shop galah: much reform was stuffed up

As someone who, back in the day, did his share of being one of Paul Keating’s pet shop galahs – screeching "more micro reform!" every time they saw a pollie – I don’t cease to be embarrassed by the many supposed reforms that turned into stuff-ups.

My defence is that at least I’ve learnt from those mistakes. One thing I’ve learnt is that too many economists are heavily into confirmation bias – they memorise all the happenings that affirm the wisdom of their theory, but quickly cast from their minds the events that cast doubt on that wisdom.

Well, let me remind them of a few things they’d prefer to forget.

Of course, it’s not the case that everything done in the name of "micro-economic reform" was wrong-headed. The floating of the dollar was an unavoidable recognition that the era of fixed exchange rates was over. And the dollar’s ups and downs have almost always helped to stabilise the economy.

The old regulated banking system wasn’t working well and had to be junked. With the rise of China in a globalising world, persisting with a highly protected manufacturing sector would have been a recipe for getting poorer. Nor could we have persisted with a centralised wage-fixing system or a tax system that failed to tax capital gains, fringe benefits and services – to name just a few worthwhile reforms.

Many privatisations were justified – the government-owned banks, insurance companies and airlines – but the sale of geographic monopolies (ports and airports) and natural monopolies (electricity and telephone networks) was a step backwards, mainly because governments couldn’t resist the temptation to maximise the sale price by preserving the businesses’ pricing power at the expense of consumers.

The conversion of five state monopolies into the national electricity market proved a monumental stuff-up at all three levels: generation, transmission and retail. It quickly devolved into an oligopoly with three big vertically integrated firms happily overcharging consumers at every level, with collateral damage to the use of carbon pricing in reducing greenhouse gas emissions.

We’ve learnt that “markets” artificially created by governments and managed by bureaucrats are – you wouldn’t guess – hugely bureaucratic, with the managers susceptible to “capture” by market players. The gas market has also been an enormous stuff-up, threatening the survival of what remains of Australian manufacturing.

The ill-considered attempt to treat schools and TAFEs and universities as being in some kind of market, where fostering competition between them and paying teachers performance bonuses would spur them to lift their performance, proved an utter dud.

Had the harebrained plan to deregulate uni fees not been stopped, it would have made even worse the chronic disorientation of the nation’s vice chancellors on what universities are meant to do and why they’re doing it. Lesson: trying to turn non-market parts of society into markets, while blithely ignoring all the obvious reasons such "markets" would fail, is a fool’s errand.

Which brings us to the half-baked idea of trying improve the provision of taxpayer-funded services by making their delivery “contestable” by for-profit providers. It's been an expensive failure pretty much everywhere it’s been tried: childcare, employment services, vocational education and training, and aged care (see present royal commission), not to mention privately run prisons and offshore detention centres. How long will it be before we’re having a royal commission into the abuses of the largely outsourced national disability insurance scheme?

Why have so many reform programs ended so badly? Partly because of the naivety of econocrats and other proponents of "economic rationalism". They had no notion of how far the grossly oversimplified neo-classical model of markets they carry in their heads misrepresented the big bad real world.

And many of them, having spent their working lives solely in the public sector, had no idea of how wasteful or bureaucratic the supposedly rational private sector could be. Actually break the law if they thought they wouldn’t get caught because corporate law-breaking wasn’t being policed? Sure. Rip off the government because the bureaucrats wouldn’t notice? Love to.

But there’s another reason so many reforms blew up. Because naive econocrats failed to foresee the way reforms intended to leave consumers or taxpayers better off could be hijacked by Finance Department accountants looking to cut government spending and produce "smaller government" by whatever expediency possible (see uni fee deregulation) and politicians looking to win the approval of big business or to move money and influence from the public sector column (them) to the private sector column (us).

Lesson: if a venal politician can find a way to sabotage micro-economic reform to their own advantage, they will.
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Monday, February 11, 2019

Politicians, economists will decide if bank misbehaviour stops

In the wake of the Hayne report on financial misconduct, many are asking whether the banks have really learned their lesson, whether their culture will change and how long it will take. Sorry, that’s just the smaller half of the problem.

You can’t answer those questions until you know whether the politicians and their economic advisers have learned their lesson and whether their culture will change.

Why? Because the game won’t change unless the banks believe it has changed, and that will depend on whether governments (of both colours) and their regulators keep saying and doing things that remind the banks and others on the financial-sector gravy train that the behaviour of the past will no longer go undetected and unpunished.

One of Commissioner Hayne’s most significant findings was that almost all the misbehaviour he uncovered was already illegal. Which raises an obvious query: in that case, why did so much of it happen?

Hayne’s answer was “greed”. That’s true enough, but doesn’t tell us much. Greed has been part of the human condition since before we descended from the trees. But greed has been channelled and held in check by other factors – particularly by social norms that disapprove of it and find ways to censure people who aggrandise themselves are the expense of others. In old times, social ostracism was enough.

So, since banks and other financial outfits haven’t always been willing to exploit their customers the way they have recent decades, the question is: what changed?

One explanation is that the economy’s become a bigger, more complex, more impersonal place, where the exploiter and the exploited don’t know each other. Where the exploitation is carried out by four of the biggest, most sprawling and intricate computer systems in the country.

Where I can spend my obscenely large pay cheque without seeing the faces of the people I’ve ripped off flashing before my eyes. Indeed, in my suburb, all of us get huge pay cheques. And I don’t feel guilty; some of them get much bigger cheques than me.

But another part of the explanation must surely be that things started changing after the triumph of “economic rationalism”, the introduction of microeconomic reform, and the deregulation of the financial sector in the second half of the 1980s.

In the highly regulated world, there was less scope and less incentive to mistreat customers. Competition was limited and there was little innovation. Deregulation was intended to spur competition between the banks and give customers a better deal.

I’m not saying bank deregulation was a bad idea. It did bring innovation (we forget that banking and bill-paying are infinitely more convenient than they were) and you no longer have to live in a good suburb to get a loan from a bank.

And the banks do compete far more fiercely than they used to. It's just that they compete not on price (as the reformers assumed they would) but on market share and which of the big four achieves the biggest profit increase.

In this they’ve behaved just as you’d expect oligopolists to behave.

In the meantime, economic rationalism sanctified greed (the “invisible hand” tells us the market leaves us better off because of the greed of the butcher and the baker) and economists invented euphemisms such as “self-interest” and “the profit motive”.

Then, after economists got the bright idea of using bonuses and share options to align management’s interests with shareholders’, big business elevated “shareholder value” to being companies' sole statutory obligation.

Now, however, when Hayne says the banks gave priority to sales and profits over their customers’ interests, everyone’s rolling around in horror.

And politicians and econocrats are feigning surprise that financial regulators, long given a nod and wink to dispense only “light” regulation of the players (and denied the funding to give them any hope of successful prosecutions), did just as they were told.

Unless the econocrats and their political masters are willing to accept the naivety that marred bank deregulation, the harm ultimately done to bank customers – ranging from petty theft to life-changing loss – and the system’s susceptibility to political corruption, the banks’ culture won’t change because the will to change it won't last.

The existing prohibitions on mistreatment of customers need to be made more effective, as proposed by Hayne but, above all, the law needs to be policed with vigour – including adequately resourced court proceedings – so the banks realise they have no choice but to change.
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Monday, October 29, 2018

Sensible electricity rules await the next government

You can call it populism or you can call it desperation. In the case of Scott Morrison’s recent problem-solving efforts, desperation fits better. And wouldn’t you be?

Morrison is probably right in concluding it’s too late in the piece to be worried about carefully considered, long-lasting solutions to the many problems contributing to his government’s unpopularity.

We’ll know soon enough whether his flailing efforts to apply quick fixes will be sufficient to secure his government another term in office.

But only after whichever side wins is facing a clear run of years before the next election will we see how our political class responds to the bipartisan – and world-wide – loss of faith in neoliberalism and its use of deregulation and privatisation to pursue the nirvana of Smaller Government.

Only then will it be clear whether flawed ideology has been replaced by unthinking populism as advocated by the shock jocks, or by a more realistic, more nuanced approach to intervention in markets that aren’t serving consumers well.

Meanwhile, Morrison has an election to avoid losing. If Tony Abbott hadn’t greatly compounded the problem by abolishing the carbon tax, you could feel a bit sorry for Morrison. The monumental stuff-up of the move to a national electricity market, with its price blowouts at every level – generation, transmission and distribution, and retail – was decades in the making.

Only with the doubling of retail prices over the past decade has realisation dawned that the federal government can’t escape ultimate political responsibility for a “national” market run by a squabbling committee of state and territory energy ministers.

But Morrison’s announcement last week of a desperate collection of good, bad and indifferent measures to get retail prices down in a hurry – or at least appear to be getting them down – seems no better than a crude attempt to bludgeon some quick retail price cuts out of the three oligopolists that have come to dominate the market.

As was powerfully demonstrated by the events leading to the overthrow of Malcolm Turnbull, no government whose members can’t agree that the threat of climate change is real is capable of achieving a policy regime that restores a stable future for the energy industry.

Don’t be fooled, however, by the industry apologists claiming the only real problem is the uncertainty about future governments imposing a price on carbon emissions, and the rises in the wholesale price this is now causing as coal-fired power stations die of old age without adequate replacement.

That relatively new problem accounts for little of the retail price doubling over the past decade – which is the underlying reason for the public’s anger over the cost of electricity.

Putting the blame on the inability of the two federal political sides to agree on a response to global warming sweeps under the carpet the oligopolists’ gaming of the wholesale market, the distribution industry’s gaming of its price-setting formula, and the blowout in retail margins following the state governments’ deregulation of retail prices.

Companies at the distribution and retail levels are earning rates of profit far higher than they need to cover their cost of capital and risk-bearing.

The public has every right to be up in arms, and the federal government every right to step into the mess in search of ways to reduce profitability and prices at the retail level. Particularly because what the feds would be doing is correcting years of misregulation by dysfunctional state governments.

It’s not a question of deregulation versus regulation. Electricity has always been more highly regulated than other industries and always will be. The national electricity market is, after all, a creation of government, which from day one has been (not very well) regulated by public authorities.

Rather, it’s a question of how and why you intervene to correct the mess. Whether you act carefully and reasonably to get the industry moving towards a future that’s sustainable financially and environmentally.

Any changes need to be fair, although in this the balance should err in favour of fairness to consumers (and business users) who’ve been overcharged for years. The industry can’t be allowed to use the trade union argument that their present rates of profitability are “hard-won gains” that must remain sacrosanct.

When something shouldn’t have been allowed to happen in the first place, it’s no crime to belatedly reverse it. Talk of “sovereign risk” is self-interested bulldust. You can’t have a democracy in which governments are forbidden to change course.

But none of this seems to describe Morrison’s motivations. He want price cuts, he wants them now, and he doesn’t much care what stick he waves to get them.

A word of free advice, Scott: claiming to have achieved bigger price cuts than the punters see in their quarterly bills will only make them angrier.
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Monday, February 12, 2018

Economists do little to promote bank competition

The royal commission into banking, whose public hearings start on Monday, won't get a lot of help from the Productivity Commission's report on competition within the sector. It's very limp-wristed.

The report's inability to deny the obvious - that competition in banking is weak, that the big four banks have considerable pricing power, abuse the trust of their customers and are excessively profitable – won it an enthusiastic reception from the media.

Trouble is, its distorted explanation of why competitive pressure is so weak and its unconvincing suggestions for fixing the problem. It offered one good (but oversold) proposal, one fatuous proposal (to abolish the four pillars policy because other laws make it "redundant") and a lot of fiddling round the edges.

It placed most of the blame for weak competition on the Australian Prudential Regulation Authority, egged on by the Reserve Bank, for its ham-fisted implementation of international rules requiring banks to hold more capital, and for its use of "macro-prudential" measures to slow the housing boom by capping the banks' ability to issue interest-only loans on investment properties.

The banks had passed the costs of both measures straight on to their customers. It amounted to an overemphasis on financial stability (ensuring we avoid a financial crisis like the Americans and Europeans suffered) at the expense of reduced competitive pressure on the banks.

This argument is exaggerated. Even so, it's quite likely that, in their zeal to minimise the risk of a crisis, APRA and the Reserve don't worry as much as they should about keeping banking as competitive as possible.

The report's proposal that an outfit such as the Australian Competition and Consumer Commission be made the bureaucratic champion of banking competition, to act as a countervailing force on the committee that makes decisions about prudential supervision, is a good one.

The report's second most important explanation for weak competition is inadequacies in the information banks are required to provide to their customers. Really? That simple, eh?

See what's weird about this? It's blaming the banks' bad behaviour on the regulators, not the banks. If only the bureaucrats hadn't overregulated the banks, competition would be much stronger.

Why would the bureaucrats in the Productivity Commission be blaming other bureaucrats for the banks' misdeeds? Because this is the prejudiced, pseudo-economic ideology that has blighted the thinking of Canberra's "economic rationalist" econocrats for decades.

Whatever the problem in whatever market, it can never be blamed on business, because businesses merely respond rationally (that is, greedily) to whatever incentives they face. If those incentives produce bad outcomes, this can only be because market incentives have been distorted by faulty government intervention.

Market behaviour is always above criticism; government intervention in markets is always sus.

When the report asserted that the big banks had used the cap on interest-only loans as an excuse for raising interest rates, and would pass the new bank tax straight on to customers, there was no hint of criticism of them for doing so. They were merely doing what you'd expect.

In shifting the blame for these failures onto politicians and bureaucrats, the report fails to admit that the distortion that makes interest-only loans a worry in the first place is Australia's unusual tolerance of negative gearing and our excessive capital gains tax discount.

In criticising the bank tax, the report brushes aside the case for taxpayers' recouping from the banks the benefit the banks gain from their implicit government guarantee, and the case for taxing the big banks' super-normal profits (economic rent), doing so in a way that stops the impost being shunted from shareholders to customers.

Here we see a hint that the rationalists' private-good/public-bad prejudgement​ is only a step away from Treasury being "captured" by the bankers it's supposed to be regulating in the public's interest, in just the way it (rightly) accuses other departments of being captured.

The report's criticism of existing interventions would be music to the bankers' ears. Its fiddling-round-the-edges proposals for increasing competitive pressure have one thing in common: minimum annoyance to the bankers.

The Productivity Commission's rationalists can't admit that the fundamental reason for weak competition in banking comes from the market itself: as with many industries, the presence of huge economies of scale naturally (and sensibly) leads to markets dominated by a few big firms.

Market power and a studied ability to avoid price competition come with the territory of oligopoly. Have the rationalists spent much time thinking about sophisticated interventions to encourage price competition in oligopolies? Nope.

Have they learnt anything from 30 years of behavioural economics? Nope. When you've learnt the 101 textbook off by heart, what more do you need?
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