Justifying protection in the book market

Books in Australia are expensive. Really expensive. It has been well known that buying books from Amazon or 'The Book Depository' and having it shipped from the UK or USA has been cheaper than walking down to Dymocks. The reason is protectionist measures imposed by the government.

It is illegal to import for resale any book that an Australian publisher has the rights to. Therefore if an Australian publisher sells a book at $50 and a UK or US publisher sells the book for $15 then buying it in Australia leaves the consumer $35 worse off and until the internet there was nothing you could do about it.

The rules that cause this are called the 'parallel import rules' and have applied in several sectors. Recently the government accepted the recommendations of a report that all such rules should be abolished.

The argument for the rules on books has been that it protects Australian authors. By protecting Australian publishers from competition this raises all book prices.  Therefore the Australian authors can be published because the returns from Australian publishing are high enough to justify the investment.

Of course the big loser is the Australian book buyer. They pay more for all books, regardless of who wrote them. The big gainers are Australian publishers who can charge more because they are protected from competition from international publishers. For example a Harry Potter novel could be published overseas and in Australia but the overseas copy cannot be sold in Australian bookshops despite being a third of the price.

Would fewer Australian authors be published if the rules were dropped? Probably, but only because their product was uncompetitive - that is consumers preferred overseas alternatives. That is improving allocative efficiency.

Would fewer people be employed in the publishing industry if the rules were dropped? Certainly, because printing overseas is very much cheaper than printing in Australia. This means improved productive efficiency. (Many point out that overseas printing is also of much higher quality as their equipment and technology is superior. Improved allocative efficiency too.)

Would fewer people be employed in book selling in Australia? Probably not. Lower prices will increase book sales if the law of demand is right. Of course they may be employed differently to at present, but there is no reason why bookselling should see less activity at all.

Therefore the parallel import rules are an example of old fashioned protectionism with little to recommend it. The losers are the Australian public who will see their consumer surplus transferred to publishers or lost completely.

The Guardian covers the story here

This story is relevant to both IB and VCE students. IB students will study protectionism in international economics and VCE students will also look at the goal of external stability and policies to achieve it.

Increasing industry concentration a concern

Economists have long understood that competition between firms brings the advantages of lower prices, improved quality and greater consumer choice. This is because firms deliver on these or they will be competed out of the market. 

The Australian Competition and Consumer Commission (ACCC) chairman has warned that market concentration (the percentage of market share held by the biggest firms) has risen to a level where consumers are possibly going to be worse off.

If a firm has monopoly power then they typically charge more and sell less, but earn higher profits. Over the last few decades mergers and takeovers have led to a very high proportion of Australian output being concentrated in the top 100 firms.

This provides a problem for the ACCC who regulate competition. The article below suggests that a change of rules whereby the firms that merge or want to takeover another have to prove the result will not harm competition. At present the ACCC have to prove it would harm competition.

An interesting point made by the ACCC is that if we want the benefits of economies of scale to work through to lower prices then we have to maintain a competitive environment. In other words a merger/takeover may improve productive efficiency but harm allocative efficiency.

The ABC cover the story here

This article deals directly with competition policy in Australia so is directly relevant to VCE economics. This is a part of IB economics also, and the harm that monopolies do to efficiency is often visited on Paper 1 of Higher Level in questions on the theory of the firm.

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.

Regulating monopoly power - a good idea?

The European Commission has jut rules that there cannot be a merger of two of the four mobile phone network operators in the UK. They have done this because they say the reduction in competition this would involve could harm the interests of consumers.

There was a proposed takeover by the '3' network of the O2 network. The cost of the deal at nearly 13 billion Euros was enough to attract the attention of the EU Competition Commissioner.

The merger was banned because the EU feared that the result of having just three providers in the market would confer too much monopoly power on the remaining firms. They argue that prices would rise and the service quality fall as a result.

The reason that a high concentration ratio can be bad for consumers is the loss of efficiency that can result:

Productive efficiency falls because there is less competition and no need to keep costs low. There is also less incentive to invest in the service to improve because the chances of loosing market share is minimal.

Allocative efficiency is reduced as there is less need to provide consumers with an innovative new service and high quality as the alternative services are diminished.

Dynamic efficiency is reduced because there is less need to invest. An important point here is that the three remaining firms are more likely to act in their mutual interest and not compete strongly. It is not collusion, that is illegal, but a 'Nash equilibrium' becomes more likely. Each firm realising that strong competition is effectively cut throat they act in a way that maximizes mutual profit.

This is an excellent example of competition policy in action. Some will argue that banning the merger it is a bad move in the long-run as mobile networks need to become international, not national. That's a trade-off of long-run efficiency gains for short-run losses the EU is unwilling to make.

The BBC covers the story here

The detail of this story is of most interest to IB students studying market structures and government intervention. However VCE students should see parallels to the operation of the ACCC and the costs of monopoly power.

ACCC aims to prevent market dominance

One of the roles of the Australian Competition and Consumer Commission (ACCC) is to ensure that too much monopoly power isn't created through mergers or acquisitions. A often quoted example of too much monopoly power is the retail grocery sector in Australia.

Coles and Woolworth's dominate the grocery market with around 80% market share. While this is actually falling as chains like Aldi enter the market by world standards this is a very high share for two companies. The potential for consumers to pay higher prices, or suppliers to be 'bullied' is significant.

Therefore the ACCC is looking at the possibility of Coles acquiring greater market share in the ACT by buying nine Supabarn stores. Although the 'big two' have a lower market share in the ACT than in the rest of Australia (Coles has just 21% of the ACT market) the ACCC don't think it's a good idea to allow Coles to increase their share by as much as they wish to.

The ACCC won't block the entire deal, but will insist some stores of the Supabarn chain go to other retailers. This will allow some of the smaller players to grow and increase competition in the market. That's good for consumers.

The final ACCC decision is expected on Thursday.

The International Business Times covers the story here

This article is relevant to both IB and VCE students on the matter of market structure, concentration ratios and policy to reduce market failure.

Unfair practice? ACCC takes action against Jetstar and Virgin

When a market is an oligopoly the chances of tacit collusion is high. There are only a few airlines operating in the Australian domestic market and the ACCC believes they are operating unfairly.

The issue is the way the airlines advertise a price and then add fees as the booking progresses. The particular issue is how there is a charge for using normal methods of paying.

The ACCC is taking legal action because they feel that it is the low level of competition which is the cause of the problem. 

The ACCC argument might be this. The airlines are deliberately hiding the fees to make them look more attractive to customers. Because the airlines know that they will both make more money by doing this they don't try to compete the fees away. If there was true competition then these high fees would be reduced as an airline started to advertise 'no hidden charges'. 

It is the role of the ACCC to look for market failures due to monopoly power. In this case they may have a point. Customers are being mislead. However if the practise was stopped would the 'headline' airfare rise by the same amount?

The ABC report the story here

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