Competition: Too Much of a Good Thing?

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In last month’s edition of InSight, I suggested that the notion that more choice
is always better can be taken too far. Too much choice can overload our
capacity to choose wisely, and there are markets, such as education, where
expanding choice for some means constraining choice for others. There are other
markets, such as electricity and health insurance, where there is “choice”
without variety.

Expanded choice results, in part, from our economy having opened up to
expanded competition – an expansion resulting from deliberate public
policy. It is useful, therefore, to ask whether competition policy has
been pushed past the point where it confers net benefits.

Older Australians remember an era of much less competition. Buying
a washing machine or a television didn’t require much search, for all retailers
offered the same price – a price set by the manufacturer or importer, with the
threat of refusal to supply retailers who discounted. International
airfares were set by the International Air Transport Association, while
domestic fares were set within the Two Airline Policy. The Commonwealth
Government, armed with tariffs and import quotas, was vigilant in protecting us
from access to cheap clothing, cars and electronics. And to make sure we didn’t
shop around too much, state governments enforced restricted trading hours;
anyone with a full-time job had a window of two and a half hours on a Saturday
morning to do a whole week’s shopping.

Image: Thomas Hawk

It was not until 1974 that Australia got its first Trade Practices
Act, outlawing, among other practices, collusive pricing and retail price
maintenance. In 1995 the Commonwealth and states got together to endorse
a national competition policy,
which committed governments to remove most remaining constraints on
competition. It is notable that both these moves, aimed at promoting
market competition, were the initiatives of Labor governments.

There is no question that we have benefited from these reforms.
But have they gone to the point that there are diminishing, or even negative
returns? Does all competition bring benefits, or are there some areas
where the costs outweigh the benefits?

Competition policies, enforced by Commonwealth and state regulators, can
outlaw practices such as collusion and overt deception, but these safeguards,
in themselves, do not ensure consumers enjoy all the benefits competition is
supposed to bring. These regulations are aimed mainly at ensuring
suppliers compete with one another and that they are truthful in their claims – but there are many other conditions to be met before consumers enjoy the full
benefits of competition.

The main demand side condition to be satisfied is that buyers are
well-informed as to the price and quality of goods on offer. In some
markets this happens with only a little nudging from the regulators. In
supermarkets prices are posted, foods have ingredient labelling, and a poor
purchase is not very costly; one can switch brands on the next visit. A product
like superannuation presents a different situation: prices (mainly agents’ and fund managers’
commissions) are opaque; comparisons are difficult, and by the time one realizes
a bad decision has been made, it is usually too late. In these markets
regulators can (and do) require firms to disclose information, but that in
itself is problematic, for the more information is provided, the more difficult
it is for people to compare offerings.

Competition authorities, such as the Australian Competition and Consumer
Commission (ACCC), generally prohibit false claims by suppliers. A
company cannot lie about its products, and there are prohibitions on
deliberately misleading claims, but there are many grey areas where suppliers
can exploit known consumer biases.

For example, a “98% fat-free” claim carries a different message from “2%
fat”. A $100 cashback offer on a $900 appliance is more attractive than a
straight offer of $800. Fear is used to sell insurance – often far more
insurance than consumers need. Marketing experts know the efficacity of immediately attractive offers with later costs
pushed into the background – “teaser” rates on credit cards and repayment
holidays for major appliances.
Competition policy in Australia,
as in many other countries, has tended to focus on ensuring firms are competing
and are not engaging in outright deception, but they have been slow to
intervene where firms deliberately exploit consumer biases.

Sometimes the wrong sort of competition thrives in markets. In the
financial services sector, for example, firms often use commission-based
selling. The salesperson (glorified with names such as “financial
planner” or “insurance broker”) is rewarded on the basis of the value of
product he or she sells, rather than the quality of the transaction. In
large part such overselling has been responsible for the present subprime
mortgage problems. Mortgage brokers competed vigorously to transact
mortgages; they were concerned simply to sell as much as they could, rather
than to sell profitable business. Banks and other financial institutions
had taken their eyes off the road, for they were seeking growth ahead of
profit. In the economists’ pure model, firms compete to sustain
profitability, but when firms compete to maximize market share, to grow, or to
benefit from political favours, consumers are usually worse off.

In some cases vigorous competition can deliver price reductions, but
with sacrifices in quality. Airlines provide a case in point. In the US, ever since
the Carter Administration deregulated airlines in 1978, there has been intense
competition in the industry, and, on some routes at least, there have been
steep price reductions. But over the last twenty years indicators of
customer dissatisfaction – number of complaints, number of passengers bumped,
lost bags, cancelled flights, delays – have risen steeply.

In most competitive markets poor quality suppliers are weeded out by
consumers switching to other suppliers, but this is difficult in
airlines. Most people do not fly often enough to establish reliable
experience, and even frequent travellers find it hard to judge – “was that five
hour delay at Dallas
due to weather, mismanagement by the airport or was it because of slack
maintenance?” Also, intense competition results in airlines going out of
business and new airlines replacing them – hardly helpful for establishing a
sound base of experience. As Nobel Prize winning economist George Akerlof
points out, when customers cannot judge quality, poor quality tends to
dominate; even if consumers are willing to pay a premium for quality,
competitive pressures force a race to the bottom.

Poor supplier behaviour is also found in industries where customers do
not have an ongoing relationship with suppliers. Dealings with used car
yards, package holiday operators, real estate agents and undertakers are
generally “once off”. They contrast with the more enduring relationships
consumers establish with local stores and regularly used tradespeople.

In fact, the more firms there are in a market, the harder it becomes for
firms and consumers to form ongoing relations. Research by David Laibson
of Harvard University suggests that the benefits of
competition rapidly diminish as the number of firms in an industry
increases. The benefit of a fourth or fifth supplier in a market is much
less than the benefit of a second or third supplier. In
other industries, firms compete strongly for new customers but once customers
make a choice they become locked in to one supplier. If switching is
difficult, the supplier enjoys a degree of monopoly power. Consider the
difficulty in changing a bank (with mortgages, periodic payments and deposits)
or an internet service provider (changing all those addresses).

Governments and competition authorities can become fixated on situations
where only slight gains can be made from improving an industry’s competitive
structure. As a case in point there is presently a huge emphasis on competition
in gasoline, but even the most rigorous application of competition policy will
deliver benefits of only a few cents a litre, or about $100 a year. In
the meantime consumers are paying dearly for financial services, spending too
much on health and general insurance, and are facing high prices for privatized
toll roads, electricity and water.

The Organization for Economic Cooperation and Development (OECD) has
been examining the question of whether traditional competition policies are
adequate to ensure consumer welfare. In Australia the Productivity Commission has recently released a report on
Australia’s consumer policy framework, which, among other recommendations,
suggests more useful disclosure of information, improved consumer education and
more consumer input into policy making.

These steps are cautious, however, for there is still
a strong belief among policymakers, particularly in treasury departments, that
competition, having delivered so many benefits, is the be all and end all of
public policy. And politicians are adept at raising distractions, such as
gasoline prices, while leaving untouched many areas where businesses are
enjoying significant privileges. We need to be on the lookout for those
distractions.

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