ECONOMY: by Emeritus Prof H.M. KolsenNews Weekly
Where competition policy fails
, November 17, 2001
H.M. Kolsen, Emeritus Professor of Economics at the University of Queensland, explains the dangers for regional Australia in an over-zealous application of competition policy.
The future of competition policy is most likely to be shaped by many factors, of which the two most important elements are:
First, recognition of errors and misconceptions in applications of what was thought to be a consistent, though undefined, set of so-called principles, apparently based on economic theory; and
Second, belated recognition of the social and equity effects of this policy.Errors and misconceptions
The Hilmer Report used a definition of competition appropriate for sports contests, but highly inappropriate for matters economic. It did, however, refer to many qualifications and ifs and buts in its recommendations.
While these qualifications were essential parts of the Competition Principles Agreement signed by all Australian Governments, they were given little emphasis in what followed. Nor was it recognised that the only specific instruments of competition policy were the amendments to the Trade Practices Act (TPA) and the Competition Principles Agreement (CPA). Thus there was no defined competition policy per se
Only the Trade Practices Act and the CPA were established and defined bases for overall, i.e., not industry-specific, policy.
The CPA required seven matters to be taken into consideration when the appropriateness of any policy or course of action was to be assessed. Of these, only the last two were related to economics. The other five were:
- ecologically sustainable development;
- social welfare and equity;
- occupational health and safety, industrial relations and access and equity;
- economic and regional development; and
- the interests of consumers.
The CPA also stated that it is neutral between types of business ownership, and not intended to promote public or private ownership.
There is little reference to these matters in public discussions. The implication has been that economic efficiency was all that mattered, despite the fact that only two of the seven matters to be taken into consideration were directed at it.
However, even if the two economic requirements are regarded as dominant, the deficiencies of the concept of competition used in applications led to many results which cannot be defended by reference to economic theory. Writing here, it is impossible to refer to more than one principal cause of error. This results from simplistic assumptions about the meaning of competition in markets.
Some four months after the Hilmer Report was published, another Report, somewhat embarrassing to the Government at the time, drew attention to that error (and others). Briefly, this second report said that if there is less competition on one side of a market, (whether between the buyers or the sellers), than on the other side, the resulting uneven distribution of market power will not result in an efficient allocation of resources.
It is not necessary to have recourse to complex economic theory to understand that the market power which the less competitive side is able to apply will be detrimental to those on the more competitive side.
The simplistic approach to this problem, the existence of which cannot be denied, was to aim for high levels of competition everywhere. Buyers and sellers were to be made as competitive as possible. What was largely ignored was that different productive activities frequently made that impossible, and that attempts to enforce so-called competitive behaviour would fail wherever the market imbalance was caused by factors such as economies of scale.
So dairy farmers and other rural producers and small producers generally, faced by the market power of processors and large retailers, were denied access to actions which would reduce the market power imbalance. Instead, the Australian Competition and Consumer Commission (ACCC) was to ensure that the market power of those who have it was not abused. Lack of success is guaranteed by the reasons for the existence of market power imbalances, which include the productive efficiencies inherent in some processes, such as retailing and processing, which do not exist, or exist at a much lower level of output, at other stages of the chain from the initial producer to the final consumer.
To apply the same rules everywhere, regardless of fundamental differences in market power at the various stages of production, does not result in an efficient allocation of resources. As the Second Report, by the Panel examining Part X of the Practices Act, put it, the "one shoe fits all" approach fails to use the countervailing economic power model where necessary. It also noted that no other country expects to solve such problems by using a monopoly regulator rather than industry specific bodies where necessary.
It should be mentioned that the ACCC has available to it, and applies it frequently, a procedure which allows for some flexibility in the "one shoe fits all" approach. This is the authorisation process, which allows the ACCC to take a wider view.
While the existence of this process deserves to be strongly supported, it is at best an ad hoc
substitute for the treatment of what are regarded as market peculiarities, but are actually market characteristics which exist almost everywhere.
Furthermore, no research has been undertaken which provides evidence for the effectiveness of the results of the authorisation process. As with other aspects of so-called competition policy, the actual results are assumed to have the effects which they are believed to have.
In the next decade, research will no doubt focus to a much greater extent on results. This will reveal the great differences between assumptions and beliefs on the one hand, and the actual effects in real markets on the other.Social effects
Economists have long recognised that decisions which affect the distribution of income require value judgments to be made, and that value judgments cannot be based on economic theory. The idea that such judgments should be made by bodies such as the ACCC, or the National Competition Council, or the local versions such as the Queensland Competition Authority, suggests that it is again based on invalid assumptions about what economic theory can and cannot do.
It surely has not escaped notice that other countries recognise that some activities are supported by notions about the wider contribution they make to society as a whole. Thus rice costs some 10 times more to produce in Japan, some dairy and other farmers in Europe survive on 10 hectares or less, and product markets are distorted by huge subsidies. These interventions are not based on concern with economic efficiency, but reflect national and community views about what the objectives of policy should be.
The reaction of bodies such as the National Farmers Federation, the National Party, and indeed all the major political parties, is to argue that it is not possible to control export markets which, based on beliefs and assumptions rather than facts, take up to 80 per cent of the relevant produce.
Even if it were true, which it is not, this "one shoe fits all" approach ignores the great differences between the different sectors. No market milk is exported, but the application to its producers is the same; and this can be applied to most vegetable farmers and others who export a small proportion, it any, of their produce.
It should be mentioned that independent research, principally by Dr Mark McGovern of Queensland University of Technology (QUT), has shown that the 80 per cent export claim is based on a quite basic statistical error. It is more like 30 per cent, with great differences between different commodity groups.
This result, published in a respected economic journal, has been rejected many times, perhaps because it makes it clear that the possibilities for some control over domestic markets cannot be rejected on the ground that export markets are dominant and outside Australia's control.
The social and equity effects of some reallocation of resources are submerged by the application of invalid economics. However, even if the economic arguments were valid - which, to repeat, they are not - the social and equity effects of any policy need to be assessed in terms of its effects on the community as a whole. This cannot be done by appointed officials, unless they are given explicit instructions by legislation.
The failure to apply all matters of relevance detailed in the Competition Principles Agreement (CPA) to policy decisions demonstrates that such matters cannot be left to the ACCC, the National Competition Council, or its local State counterparts.
It is important to recognise that the ACCC is not to be blamed for what it does. It is tightly constrained by legislation. The same cannot be said about other bodies, which have failed to take into consideration all the matters they were required to do. Nor can it be said of State Governments, which also, so far, have taken the narrow view of what is required by the CPA.Conclusion
While industry regulation generally was, in the early 1990s, in need of reform, the "one shoe fits all" approach has not been reform but wholesale abolition of the safeguards for the weaker market participants.
Those who approved of this included organisations which were supposed to represent the interests of their members, many of which were and are on the weaker market side. Instead, they approved of the application of invalid economics and inappropriate equity judgments.
It has often been suggested that free-market ideology has gripped policy makers, regardless of other considerations.
This is too simple by far. It is more likely that misunderstanding economics, or understanding a very simplistic version of its findings, has been a fundamental cause.
After all, the various clauses in the CPA which require a wide range of non-economic matters to be taken into consideration, show that the policy makers who signed it were aware of the existence and importance of matters other than simplistic economics.
Nevertheless, the failure to apply these clauses as and when required demonstrates a political inability to control the progress, and unwillingness to monitor the effects, of mindless applications of the competition policy's most simplistic version.
This political failure will dominate discussions in the future, and will result in much amendment to what is now, without definition, called competition policy.