Wednesday, August 4, 2010

Competition Series Part I: Experimentation

The annual ACCC Regulatory Conference was held last week at the Gold Coast. At a time when various governments are intervening to separate Telstra’s business, sell public railways, subsidise a fibre broadband network, and introduce competition in water markets, any evidence on the effectiveness of competition reforms in such network industries would be helpful. Yet my take home message was that nobody is sure if competition reform has provided, or even can provide, the social benefits it was designed to achieve.

Ironically, in the second session of the conference the following findings were put forward: most circumstances, profit maximising vertical integration decisions are efficient, not just from the firms’ but also from the consumers’ point of view. The vast majority of studies support this claim,.. even in industries which are highly concentrated…

However, the thrust of competition reform is directed at unbundling vertically integrated monopolies to reduce potential abuse of market power.  Railways, electricity, and telecommunications are classic examples, yet a quarter century of evidence shows that vertical integration is in fact the efficient outcome for both producers and consumers. I would note however, that even where market structures appear to be competitive, price competition and innovation may still fail to eventuate.  On the other hand, monopolies may innovate simply due to a the threat of competition. Arguing that competitive outcomes will be achieved based on market structure alone is flawed.

That got me thinking. Is competition reform more about ideology than social gains through efficiency? Are we just swapping government incompetence at regulating and incentivising its monopoly with incompetence at developing sufficient regulation for a competitive market operate while still relying on government owned monopolist components of the value chain?

This post is the first in an August series on competition which will follow my emerging understanding of this controversial topic. I hope to investigate key theoretical assumptions, investigate the history of competition reform, compare theoretical outcomes with real evidence, and identify regulatory shortcomings. In doing so my personal opinions will become known, yet I hope that some debate will challenge these opinions. Any comments and criticisms are welcome.

The competition experiment

Australia’s big push towards competition reform of nationalised industries came from the 1993 Hilmer Report. In this report, Fred Hilmer kept his eye on the prize.

Competition policy is not about the pursuit of competition per se. Rather, it seeks to facilitate effective competition to promote efficiency and economic growth while accommodating situations where competition does not achieve efficiency or conflicts with other social objectives. These accommodations are reflected in the content and breadth of application of pro-competitive policies, as well as the sanctioning of anti-competitive arrangements on public benefit grounds.

The Austrian School has a different take, suggesting that competition is in fact a “permanent economic process”, and that “market dominance was always necessarily temporary in the absence of monopoly-creating government regulation.” Competition is, by default what happens in the absence of government intervention. Indeed, one could argue that competition is simply human nature – the desire to improve one’s lot. Privatisation gives a profit motive to promote competition, but there are other surely other ways to harness our competitive drive.

One could say that competition reform is focussed on the very limited definition of competition in pursuit of profit - privatisation by another name. Why competitive pressure cannot be utilised by government monopolies remains an open question.

Of course, most people would argue that you cannot fully privatise a monopoly for both reasons of equity and for fear of the abuse of market power. To use the profit motive to promote competition therefore, the monopoly supply chain most be vertically unbundled. This then adds layers of cost to the final product, which may more not, outweigh the gains from competition driven innovations.

I asked Fred Hilmer and Stephen King during this session why they had such a long list of industries they believed could be improved by competition reform, when José A. Gomez-Ibañez’ earlier presentation had highlighted the many subtleties and challenges of improving productivity through such reform, and the potential for making the situation worse. Indeed, I highlighted a plethora of other more likely explanations for the decline in Australia’s productivity this decade, including speculative housing investment, large infrastructure investment (much of which is duplication), a technology plateau following the ICT boom, Dutch disease, and more.

Their answers gave a glimpse into the ideology behind these reforms.

To paraphrase, it is better to have a go and be wrong, then let things continue as they are. We don’t know if it’s broke, and we don’t know how to fix it, but we’ll do it anyway. I can’t think of any other part of life where such logic prevails.

While I know firsthand the inefficiencies of government control, where revenues are assured and the incentive to innovate is low, this does not preclude alternative arrangements to provide incentives for government owned corporations. Nor does it mean that the waste (deadweight loss) generated by private competitive firms is less than that of a government, or even a private, monopoly. For example, recent findings even suggest that government owned bank are better for economic growth:

...if anything, government ownership of banks has been associated with higher long run growth rates, even after controlling for institutions and other variables...

Competition was a means to a productivity improving end. Now, after much experimentation, we are discovering that competition doesn't always arise, and private markets don't always deliver the desired social outcomes. Our institutions however, seem inclined not to notice the costs of competition reform.

Part II will examine relevant economic theories of competition, monopoly and vertical integration.

1 comment:

  1. A classic example of what you are talking about is the privatization of electricity retailing.I have personal experience of this in QLD from the customer perspective.

    This was an initiative of the Beattie/Bligh Labor government and it is well known that this government is corrupt and incompetent.The result is 13 registered electricity retailers in QLD and over 12,000 closed case complaints to the Energy Ombudsman Queensland in 2009/10.

    So,what is the attraction for these players?From my experience it is the opportunity to rip off electricity users with the connivance of the government.The executives pay themseves inflated saleries plus perks then,when the rotten edifice goes belly up they depart the scene leaving a swag of debtors with little or no recourse - rinse and repeat.JackGreen Energy is a recent example of this.There will be many more.

    Failure to recognize and pay pensioner entitlements and the government facilitated practice of paying credits,from solar power feed in for example,only once per year,are some of the scams used to maximize profit.I'm sure there are other lurks and perks which I am not aware of.