Following my previous post on the Debt Reduction Taskforce, I thought I would provide some links that explain my views on monetary theory more explicitly. Essentially, the money multiplier is a myth, and money is created first by debt, and reserves are accumulated after the fact if necessary - try Bill Mitchell’s blog for an explanation of Modern Monetary Theory (which is close to my personal views), and this site for more detailed discussion on the multiplier myth.
Ross Gittins reiterates my population growth arguments
Environmental concern and unemployment – a negative correlation. We are all too happy to worry ourselves about the environment when the going is good, but in a recession we suddenly shuffle the environment down our list of concerns.
Update on skills shortage and emigration of Australian trained professionals. This recent research suggests that “positive selectivity is stronger where the reward to skill in the destination is relatively large”. Translation: those who pay get the skills they desire.
Economists applying statistical techniques to strange social phenomena - worship and sacrifice:
The theory we test is that, when faced with uncertainty, individuals attempt to engage in a reciprocal contract with the source of uncertainty by sacrificing towards it. In our experiments, we create the situation whereby individuals face an uncertain economic payback due to “Theoi” and we allow participants to sacrifice towards this entity. Aggregate sacrifices amongst participants are over 30% of all takings, increase with the level of humanistic labelling of Theoi and decrease when participants share information or when the level of uncertainty is lower. The findings imply that under circumstances of high uncertainty people are willing to sacrifice large portions of their income even when this has no discernable effect on outcomes.
The Superstar Effect – when you receive massive gains from being marginally better than second best. The paper is here. I read once that the Beatles were probably underpaid for the wellbeing they imparted on the masses through their music. My view was that they earned a pretty penny. They were probably only a little better than the next band that would have formed and become an international sensation had the Beatles never existed. In the purest economic sense they were superstars.
Wednesday, August 11, 2010
Tuesday, August 10, 2010
Population problem? It’s called longevity
Population growth advocates often rely on the ‘age dependency ratio’ as their core economic argument. This ratio is the population aged over 65 divided by the population aged 15-64. To give this measure meaning there is an assumption that people will not work beyond age 65 and will therefore be need to be financially supported by those at a working age. Workers will get less of the return on their productive output because it needs to be shared with more non-workers. Essentially, the percentage of people in the formal economy will decline.
I have a different opinion on the age dependency ratio. I see it as a shining beacon of success. People are working for shorter periods of their life. We as a group are finally taking some of our productivity gains of the past half-century in the form of leisure time.
Whether or not you agree this a problem, the suggested solution of population growth is, in reality, counterproductive, and will only aggravate the situation. An increase in the dependency ratio is principally caused by improving longevity. If each generation lives longer than the last we will face this problem even with a growing population. Simply adding more at the bottom of the population pyramid to keep it bigger than the top has the apt label ‘population Ponzi scheme’. Indeed, to counteract this trend would require a significant increase in the natural birth rate, or age biased migration policies, or even the extreme scenario of sending migrants back home when they hit 65. None of these are desirable.
Australia’s age dependency ratio is 16th out of this comparison of 20 developed nations; none of whom appear to be in a hurry to stimulate population growth to ‘solve’ this problem. Sweden, Norway, UK, USA, Denmark, Germany and Canada all appear to cope quite well with their demographic fortunes. Our culture, financial structures and welfare system, are still adapting to a population pyramid becoming more cylindrical.
Notably, on one side of the debate are the vested business interests. Businesses which face demand limits per person (a single person can only consume one of the same newspaper per day) and are limited to domestic consumption (which foreigners are interested in Australian newspapers) have the most to gain from population growth. The other side includes a fair swag of the rest of us, including Dick Smith, who will be a guest in many living rooms Thursday night when he airs his anti-population growth documentary.
Overcoming the apparent economic strain of age dependency issue is extremely straightforward. People need to save during their productive years to be self supporting during their retirement years. Isn’t that the point of superannuation? This dissaving during retirement also shifts wealth to the next generation.
There are a number of other factors at play which are consistently overlooked in the age dependency argument.
- People will work longer. Seventy will be the new sixty. A gentleman I used to work for is 65 this year and is looking to acquire new skills for the next phase of his career.
- People will spread their work time over the life much better, possibly taking intermittent retirements between careers. They will probably work part time and casually long after 65.
- The participation rate may improve
- Productivity of the workforce will improve
- The population aged under 15, who are also dependent, will shrink
- Have the population minister put forward a stable population by 2030 as a goal for Australia
- Encourage older people still dependent on welfare into casual/part time work. This can be achieved by allowing up to, say, $15,000 to be earned before they lose any pension payment
- Remove the baby bonus
- Possibly phase in a reactive immigration quota based on last year’s population change to meet the target set in point 1
- Allow proceeds from the sale of a principle place of residence for those above 65 to be exempt from affecting social security allowances for a fixed time period – maybe 5 years. This encourages financial independence in the long run.
- Incrementally increase the pension age starting at a future point. In Germany it is now 69. We could make it say 66 on 2014, 67 in 2017, 68 in 2020, 69 in 2023, 70 in 2024.
Sunday, August 8, 2010
Debt reduction taskforce - bad timing
Tony Abbott recently announced his plan to establish a debt reduction taskforce to reduce government debt that he believes Labor foolishly incurred. I have no problem with governments paying down debt and aiming to have a zero debt balance over the business cycle, but does he really think that governments should pay down debt while the citizenry is trying to do the same? To me this sounds like a recipe for disaster.
Debt deflation is what happens when indebted households and businesses start to pay off debt after a period of debt accumulation. Money used to pay debts is not used for consumption and no longer circulates in the economy. This decreases demand, but also reduces the money supply. The net effect is to slow economic activity and reduce prices (deflation). To read quality analysis of debt deflation read Steve Keen’s superb articles here.
The government response to this should be to print money. Because a portion of the new money is used to pay debts, a far smaller portion circulates in the economy to cause inflation. If it is done well, it should slow deflation, keeping demand and prices stable, and allow debts to slowly be repaid without the value of debt rising in proportion to incomes. Whether this will promote further malinvestment (investing in non-productivity improving assets) remains to be seen.
Establishing a taskforce is a clear sign that it is not Abbott’s intention to pay down government debts by printing money. His plan appears to be the reduce government spending to pay debts – the exact same thing households are currently doing.
This will only exacerbate the decline in demand and accelerate our march towards deflation.
Debt deflation is what happens when indebted households and businesses start to pay off debt after a period of debt accumulation. Money used to pay debts is not used for consumption and no longer circulates in the economy. This decreases demand, but also reduces the money supply. The net effect is to slow economic activity and reduce prices (deflation). To read quality analysis of debt deflation read Steve Keen’s superb articles here.
The government response to this should be to print money. Because a portion of the new money is used to pay debts, a far smaller portion circulates in the economy to cause inflation. If it is done well, it should slow deflation, keeping demand and prices stable, and allow debts to slowly be repaid without the value of debt rising in proportion to incomes. Whether this will promote further malinvestment (investing in non-productivity improving assets) remains to be seen.
Establishing a taskforce is a clear sign that it is not Abbott’s intention to pay down government debts by printing money. His plan appears to be the reduce government spending to pay debts – the exact same thing households are currently doing.
This will only exacerbate the decline in demand and accelerate our march towards deflation.
Competition Series Part II: Theories, assumptions
Let us look at the theory to see why the productivity gains from Australia’s pursuit of competition reform have been so hard to come by. Oliver Williamson’s 1968 model of the competition-coordination tradeoff is a good starting point.
The assumptions in Williamson’s model are that the monopoly industry has a lower marginal cost than competitive firms, that the monopolist sets their profit maximising price according to traditional economic theory, and that in a competitive market firms set their prices at marginal cost.
The graph below shows the resulting welfare implications of this model.
In this situation, while the competitive firms face higher costs (MC2), they set a price lower than the profit maximising monopolist (at P2 instead of P1). The welfare implication is that the area A is transferred from producer to consumer surplus, area B is the loss of producer surplus due to coordination costs, and area C is the gain to consumer surplus. There is a net loss of social surpluses (including all producer surplus) from competition in this model, however there are significant gains to the consumer surplus (areas A and C).
For a net gain to consumers in this model, two conditions need to be met:
1. The profit maximising price of the monopolist is higher that the marginal cost to the competitive producer (MC2 < P1), and
2. The competitive producers set prices at marginal cost (P2=MC2)
Unfortunately, neither of these conditions can be known in advance. In fact, if we drop just the second assumption, which has been proven many times to be far from realistic, the chances of a competitive market generating greater surpluses than a profit seeking monopolist greatly diminishes. In the above diagram this would mean that P2 is somewhere above MC2 (and of course we still don’t know if MC2 is below P1).
Costs associated with vertical separation and competition can be significant, including:
1. Coordination costs and risks of contract development and enforcement
2. One-off reorganisation costs
3. Costs of regulation and oversight and potentially unpredictable regulatory interpretations and legal determinations
4. Marketing and advertising costs for competitive firms
5. Insurance costs (government entities would typically self insure at a lower cost)
6. Profits (not necessary for a government entity)
Additionally, incentives change under a competitive structure. The legal profession and regulators now have a vested interest in promoting complex regulation while competitive firms may feel ‘too big to fail’ and take undue risk and malinvestment.
Another incentive change as a result of vertical separation is the classic hold-up problem (a type of path dependence I have discussed previously). Although the classic GM Fisher Body problem has apparently been resolved and was not in fact an example of this problem, there are clearly cases of technology change and investment where vertical integration sheds risk and reduces costs. For example, if railways were vertically separated so that multiple companies trains operated on a monopolist's track, new track technology (materials, gradient or other change) could not be adopted without corresponding investment in trains to run on new lines. The first mover to the new technology can be held to ransom by the second mover, thus the profit maximising outcome is for neither side to make a move.
Let us now return to the coordination costs resulting from separation. Increased transaction costs result partly from contract negotiation, but also from risk. The graph below shows that the more specialised a fixed asset, the higher the transaction costs (and risk) for the vertical separated supplier. Markets provide efficient transaction cost outcomes when very large capital investments are not highly specialised. This is not the case for most infrastructure networks.
There is of course one key benefit from competition that is not represented in these models – it is the benefit of simply having consumer choice from competition. Consumers (or intermediate producers) can use their power to choose, which provides incentive for competitive firms to innovate not just on cost saving, but on service provision. For example premium and budget services could emerge (think airlines).
One must also carefully define competition. The power of consumer choice exists even with apparent natural monopolies. For example, rail freight competes with cargo shipping, road haulage, and even air freight. There is a limit to the ability of a monopoly rail line to manipulate freight prices in light of the alternatives available. There are even alternatives to centralised electricity. In remote areas on-site electricity generation is still common. Households and businesses have the opportunity to invest in their own generation capacity should the network supplier exhibit monopoly pricing behaviour (solar, diesel, wind). Water can be sourced from rain water, bores, and recycled on site, while composting toilets are an emerging trend for the environmentally conscious.
The Austrian School’s “permanent economic process” of competition follows similar logic, and argues that “market dominance is always necessarily temporary in the absence of monopoly-creating government regulation.” All industries, no matter their cost characteristics and number of competitors, are exposed to risks from new technologies and potential competitors. It is only government designation that creates true monopolies and stifles the permanent process of competition. Such designations lead to an early 20th century trend, where “virtually every aspiring monopolist in the country tried to be designated a "public utility," including the radio, real estate, milk, air transport, coal, oil, and agricultural industries, to name but a few.”
The Austrians see little benefit from public provision of any good. Yet what they fail to acknowledge it that underpinning their vision is the assumption of competitively priced access to public property – such as roads and underground space for water and sewer, and rights to erect power lines – which due to the complexity and diversity of costs to the public, can never be appropriately priced. This feature means that governments will always retain monopoly control of access to public space which forms a key production stage (this idea will be revisted in a later post).
Before leaping onto the competition bandwagon, one should evaluate the limits of monopoly behaviour due to broader competitive threats including technology change. One should acknowledge that on most occasions, monopoly power will still be held by government in some form. Furthermore, one should look to history to examine reasons for the existence of the monopoly in the first place. This historical perspective is the topic of Competition Series Part III.
The assumptions in Williamson’s model are that the monopoly industry has a lower marginal cost than competitive firms, that the monopolist sets their profit maximising price according to traditional economic theory, and that in a competitive market firms set their prices at marginal cost.
The graph below shows the resulting welfare implications of this model.
For a net gain to consumers in this model, two conditions need to be met:
1. The profit maximising price of the monopolist is higher that the marginal cost to the competitive producer (MC2 < P1), and
2. The competitive producers set prices at marginal cost (P2=MC2)
Unfortunately, neither of these conditions can be known in advance. In fact, if we drop just the second assumption, which has been proven many times to be far from realistic, the chances of a competitive market generating greater surpluses than a profit seeking monopolist greatly diminishes. In the above diagram this would mean that P2 is somewhere above MC2 (and of course we still don’t know if MC2 is below P1).
Costs associated with vertical separation and competition can be significant, including:
1. Coordination costs and risks of contract development and enforcement
2. One-off reorganisation costs
3. Costs of regulation and oversight and potentially unpredictable regulatory interpretations and legal determinations
4. Marketing and advertising costs for competitive firms
5. Insurance costs (government entities would typically self insure at a lower cost)
6. Profits (not necessary for a government entity)
Additionally, incentives change under a competitive structure. The legal profession and regulators now have a vested interest in promoting complex regulation while competitive firms may feel ‘too big to fail’ and take undue risk and malinvestment.
Another incentive change as a result of vertical separation is the classic hold-up problem (a type of path dependence I have discussed previously). Although the classic GM Fisher Body problem has apparently been resolved and was not in fact an example of this problem, there are clearly cases of technology change and investment where vertical integration sheds risk and reduces costs. For example, if railways were vertically separated so that multiple companies trains operated on a monopolist's track, new track technology (materials, gradient or other change) could not be adopted without corresponding investment in trains to run on new lines. The first mover to the new technology can be held to ransom by the second mover, thus the profit maximising outcome is for neither side to make a move.
Let us now return to the coordination costs resulting from separation. Increased transaction costs result partly from contract negotiation, but also from risk. The graph below shows that the more specialised a fixed asset, the higher the transaction costs (and risk) for the vertical separated supplier. Markets provide efficient transaction cost outcomes when very large capital investments are not highly specialised. This is not the case for most infrastructure networks.
One must also carefully define competition. The power of consumer choice exists even with apparent natural monopolies. For example, rail freight competes with cargo shipping, road haulage, and even air freight. There is a limit to the ability of a monopoly rail line to manipulate freight prices in light of the alternatives available. There are even alternatives to centralised electricity. In remote areas on-site electricity generation is still common. Households and businesses have the opportunity to invest in their own generation capacity should the network supplier exhibit monopoly pricing behaviour (solar, diesel, wind). Water can be sourced from rain water, bores, and recycled on site, while composting toilets are an emerging trend for the environmentally conscious.
The Austrian School’s “permanent economic process” of competition follows similar logic, and argues that “market dominance is always necessarily temporary in the absence of monopoly-creating government regulation.” All industries, no matter their cost characteristics and number of competitors, are exposed to risks from new technologies and potential competitors. It is only government designation that creates true monopolies and stifles the permanent process of competition. Such designations lead to an early 20th century trend, where “virtually every aspiring monopolist in the country tried to be designated a "public utility," including the radio, real estate, milk, air transport, coal, oil, and agricultural industries, to name but a few.”
The Austrians see little benefit from public provision of any good. Yet what they fail to acknowledge it that underpinning their vision is the assumption of competitively priced access to public property – such as roads and underground space for water and sewer, and rights to erect power lines – which due to the complexity and diversity of costs to the public, can never be appropriately priced. This feature means that governments will always retain monopoly control of access to public space which forms a key production stage (this idea will be revisted in a later post).
Before leaping onto the competition bandwagon, one should evaluate the limits of monopoly behaviour due to broader competitive threats including technology change. One should acknowledge that on most occasions, monopoly power will still be held by government in some form. Furthermore, one should look to history to examine reasons for the existence of the monopoly in the first place. This historical perspective is the topic of Competition Series Part III.
Thursday, August 5, 2010
Scared of deflation?
I have always been puzzled at the assymmetry of 'flation fear'. A little inflation is good, but a little deflation is a scary thing.
Paul Krugman outlines the general argument as follows:
So the argument that deflation is a bad thing is also an argument saying that some economic problems get worse as inflation falls, and that too low an inflation rate may actually be economically damaging.
For the life of me I can't see how an inflation rate of zero can be damaging in the long run. Also, if we look at Krugman's argument in reverse, more inflation is better. Why isn't the optimal inflation rate zero instead of some positive number? Why 3% instead of 10%? Do human have an inbuilt behavioural trait that only we are able to plan and invest knowing that currency in the future will worth less rather than more?
Steve Landsburg on the other hand makes the argument that deflation fears are not justified by economic theory or evidence - I don’t see the problem in theory and I don’t see the problem in practice.
And he concludes that even if deflation is bad, it is easily solved.
Even if deflation is a bad thing, we know how to solve it. Print enough new money and people will eventually start spending it. It’s alleged that no matter how much you print, it can all just fall into the liquidity trap, and it’s alleged that this is what happened in Japan over the past decade. But I am sure the Japanese just didn’t try hard enough. Liquidity trap or not, I guarantee you there’s a central banker in Zimbabwe who knows how to fight deflation. If we really get into trouble, all we have to do is hire him.
As I have noted before, the world survived just fine for a long period of time with inflation at zero on average. Positive inflation in the long run did not occur until post WWII. Some might even argue that this is simply the longest ever business cycle stimulated by enough debt to keep inflation positive, and that the next fifty years, subject to international politics, might see prolonged deflation.
Avoiding deflation in the short run may have made the global economy far less stable in the long, long run.
Maybe it is just that with high debt levels adjusting to deflation from a persistent inflationary environment will unsettle much investment, and mean a transition period were many jobs are lost. Any thoughts?
Paul Krugman outlines the general argument as follows:
So the argument that deflation is a bad thing is also an argument saying that some economic problems get worse as inflation falls, and that too low an inflation rate may actually be economically damaging.
For the life of me I can't see how an inflation rate of zero can be damaging in the long run. Also, if we look at Krugman's argument in reverse, more inflation is better. Why isn't the optimal inflation rate zero instead of some positive number? Why 3% instead of 10%? Do human have an inbuilt behavioural trait that only we are able to plan and invest knowing that currency in the future will worth less rather than more?
Steve Landsburg on the other hand makes the argument that deflation fears are not justified by economic theory or evidence - I don’t see the problem in theory and I don’t see the problem in practice.
And he concludes that even if deflation is bad, it is easily solved.
Even if deflation is a bad thing, we know how to solve it. Print enough new money and people will eventually start spending it. It’s alleged that no matter how much you print, it can all just fall into the liquidity trap, and it’s alleged that this is what happened in Japan over the past decade. But I am sure the Japanese just didn’t try hard enough. Liquidity trap or not, I guarantee you there’s a central banker in Zimbabwe who knows how to fight deflation. If we really get into trouble, all we have to do is hire him.
As I have noted before, the world survived just fine for a long period of time with inflation at zero on average. Positive inflation in the long run did not occur until post WWII. Some might even argue that this is simply the longest ever business cycle stimulated by enough debt to keep inflation positive, and that the next fifty years, subject to international politics, might see prolonged deflation.
Maybe it is just that with high debt levels adjusting to deflation from a persistent inflationary environment will unsettle much investment, and mean a transition period were many jobs are lost. Any thoughts?
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:
...in 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 it is probably the minority of cases where competition delivers. 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.
Ironically, in the second session of the conference the following findings were put forward:
...in 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 it is probably the minority of cases where competition delivers. 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.
Sunday, August 1, 2010
Quick housing update and forecasts
The residential property bears breathed a sigh of relief with the release of the monthly RPData hedonic price index for June - down 0.7% (with Brisbane prices down 1.3%). The bulls however are happy enough with the 20% capital growth performance since June 2009.
In light of this, Steve Keen has laid out his forecast of things to come in residential property:
Firstly, with an increased stock of unsold houses on the market, buyers are likely to take yet more time to make a decision—which will add further to the backlog. If prices are falling, why hurry? The urgency will leave the buy side.
Secondly, so-called investors—whom I prefer to call speculators, since 90% of them have bought existing properties rather than built new ones—will start to consider whether they should swap from the buy side to the sell side. After all, no-one in their right mind buys an investment property in Australia for the rental returns: it’s capital gains or nothing DownUnder. Do you capitalize on gains to date, or hang on hoping that the upward trend will re-assert itself once more?
I expect these two processes to lead to an accelerating rate of decline in house prices now, as they did in the USA when “Flip That House” ceased being a winning trade.
Chris Joye has made a typically broad prediction:
Rismark had been forecasting a substantial deceleration in housing conditions back to single-digit annualised growth rates since October 2009. Over the long-run, house prices track purchasing power quite closely. Disposable household incomes were only projected to rise by about 5 per cent in 2010. We’ve had 4.7 per cent growth in dwelling values in the year-to-date. We do not, therefore, expect to see the market rise much further over the remaining year subject to labour market conditions and the course of monetary policy.
Interestingly, Joye notes the decline in housing credit outstanding, but does not seem to believe this will strongly influence prices in the near term.
Finally, over at Delusional Economics we have this gem:
There is no "soft landing" for a debt driven economy that suddenly decides to shun debt
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