Is Australian privatisation making the economy less efficient?

Australian Competition and Consumer Commission chairman Rod Sims has stated that in his view many Australian privtisations have made the economy less efficient and led to prices in those markets being higher, not lower.

Privatisation is a supply-side policy and takes two broad forms, one is removing rules from a market (called deregulation) and the other is where government owned corporations are moved to private ownership (denationalisation). Denationalisation is usually accompanied by the breaking up of the monopoly power of the organisation concerned by allowing new firms in to compete with it. A classic case is in telecommunications where Telstra in Australia and BT in the UK had monopolies on providing phone services before privatisation.

The aim of privatisation from an economists perspective is to move the market back to one where increased competition drives down costs and so increases allocative and productive efficiency. Allocative efficiency is provided by firms trying to better meet the wants of consumers. 

Successful privatisations lower the barriers to entry (often through deregulation and denationalisation together). In addition to the efficiency gains there are also improvements in productive capacity, increasing the level of Aggregate Supply. 

Governments have another motive in privatisations. They want to raise money. They can use the money to cut taxes (popular) or reduce government deficits or debt. Rod Sims is accusing the government of putting this motive in front of the others and as a result harming the interests of consumers.

A classic case is the sale of Medibank health insurance. The Abbott government shamelessly allowed premiums charged by health insurance companies to rise quickly prior to privatisation to make the potential profits look more attractive and drive up the share price.

The Sydney Morning Herald covers the story here

This article has interest to both IB and VCE students. IB students will recognise it as an example of how poorly planned privatisations can create private monopolies and work against consumer interests and failing to deliver the hoped for gains. VCE students can use it as an example of supply-side policy and a legitimate criticism of such policies in Australia.

British supermarkets - oligopoly case study

The UK has had four 'big supermarkets' since the 1980's. The market changed from one where the largest retailer held just 7% of the market to one where the largest, Tesco' had more than 25%. The chart below shows the 2014 market shares (the article linked below has a more up to date set of data, which you should compare).

Note that while there is technically a 'Big Four' the relative market shares of the four vary considerably.

Economic theory tells us that in the oligopoly market structure there are significant barriers to entry and firms are highly interdependent. It also tells us that there is a strong likelihood that firms will avoid damaging price wars because they fully understand their mutual interdependence and they all loose if they compete on price.

The article below describes how Asda are loosing both sales and profits as the market fights exactly the sort of price war we have been led to believe won't happen. This is because there are several players trying to gain additional market share. This is Aldi and Lidl, who are aggressively expanding.

So what is wrong with the oligopoly theory in this case? Actually nothing. There are strong barriers to entry in this market. The existing players have strong brand loyalty and occupy many prime locations, and they have the money to fight by advertising and discounting. However Aldi and Lidl have the money to fight too.

The barriers to entry are not high enough to prevent them entering the market and engaging in a price war. Their tactic is to sell cheap, the existing supermarkets like to emphasise quality as well, but that isn't enough to stop them.

The supermarket market is contestable if you have the financial reserves to obtain the stores and accept low profit margins. 

Who are the winners? Consumers are getting lower prices as a result of this competition, also the 'monopoly power' of the biggest players is falling which will make it harder to raise prices in the future. 

Who looses? The existing firms for sure. However suppliers of the supermarkets are coming under pressure to cut their prices so the supermarkets can cut theirs due to the market power of supermarkets as buyers. There are already stories of farmers who cannot survive on the prices they receive and other firms feeling 'bullied' to cut prices or lose the contract.

The BBC covers the story here

Work out the changing four firm concentration ratio in this market. Google can provide charts that show shares that go back further than 2014.

This article is most appropriate for IB students who require a firm understanding of how oligopoly markets might work and need examples they can compare to theory. VCE students do require a knowledge of market structure and so it is still useful for them.

Rising student numbers and the exchange rate

There has been a large rise in the number of foreign students in Australia this year. This is in sharp contrast to the situation in 2011 when numbers plumbeted and Monash University offered 400 voluntary redundancies to its staff.

According to recent figures there has been a rise of 12% in overseas students in 2015/16 with the increase in students from China being a huge 23% higher than last year.

When this size of change occurs it is fair to say that something has changed in the market. It could be a change in a condition of demand or supply. However the turnaround in numbers has nothing much to do with extra places becoming available or a sudden jump in the reputation of Australian education.

The reason that Australia is a popular student destination again is all to do with the exchange rate. In 2011 the Australian dollar (AUD) bought US$1.1, today it will buy about 73 US cents. This makes it much cheaper for foreign students to study in Australia. The relative price of Australian educational institutions has fallen and so overseas students have switched from the alternative (substitutes) course.

The chart below shows the exchange rate of the AUD against the US$ since 2009.

The rise in student numbers is one example of how the competitiveness of the Australian economy has improved as a result of the depreciation of the Australian dollar. The result has been a boost to those sectors of the economy which reply on export markets, including manufacturing. As a result Australia is recovering from the end of the mining investment boom rather better than anticipated.

Business Insider provides details on the student numbers here

IB students will want to consider whether the Marshall-Lerner conditions are met and the ultimate effect on the Current Account balance. There will, of course, inevitably be a rise in the volume of exports and a reduction in the volume of imports.

This article is of great importance to VCE students as this is an important demand side influence on the Australian economy. IB students should also be equally interested in the article as an example of the impact of floating exchange rate regimes.

The protection of QANTAS raises fares for passengers

Australia likes to protect its jobs, regardless of the harm it does to the bulk of the population. This has been a hard road for politicians to travel but many barriers to competition and trade have been reduced since the Hawke/Keating governments.

But the airline industry remains an area where the government allows significant barriers to entry to remain. There are two specifically:

1. QANTAS must be at least 51% Australian owned
2. International carriers need permission to fly into Australia

The result is that an oligopoly market in air travel with high barriers remains both within Australia and flying internationally. The result is that airfares are higher and service standards lower than would otherwise be the case.

The government are considering relaxing the rule on QANTAS ownership. This would allow a foreign carrier to buy the airline and operate it. They would be less sensitive to Australian jobs, such as servicing the aircraft abroad, but passengers would benefit from lower fares due to reduced costs.

However the best thing the government can do is sign up to the 'Open Skies' policy that operates in most of the developed world. Any airline can fly to and from a country as long as there are take-off and landing slots spare. This intensifies competition and lowers fares. The evidence suggests that international  air fares in Australia are considerably higher than for comparable journeys.

Currently the government will not grant any more flights to foreign airlines, even though they ask on a regular basis.

Imagine if Etihad, Emirates, Thai, Singapore and all the other big carriers could fly into Melbourne six or seven times a day. Plenty of spare capacity and so cheaper seats available. Some jobs would be lost at QANTAS, but more would be created by other airlines and all travellers will benefit.

Competition works and its about time the government let it.

The reaction to the QANTAS proposals is reported here

Wikipedia on Open Skies here