Focus on the worst

I've been reading Auckland University lecturer Ed Willis's excellent submission on the Commerce (Criminalisation of Cartels) Amendment Bill, which he's put up on his 'Great Government' blog. I don't know what other submitters have put in - at time of writing the submissions, which were due on April 9, haven't yet been put up on the Economic Development, Science and Innovation Select Committee web page about the Bill - but I'm completely on board with what Ed has to say.

His big argument is that we should keep criminalisation for the worst 'hard core' cartel cases, and he's right, for the various reasons he lists. I agree, but when you read the Bill you find that there's nothing in it about confining criminalisation to the worst cases. Here's the relevant clause:

82B Offence relating to cartel prohibition

(1) A person commits an offence if—

(a) the person,—

(i) in contravention of section 30(1)(a), enters into a contract or arrangement, or arrives at an understanding, that contains a cartel provision; and

(ii) intends, at that time, to engage in price fixing, restricting output, or market allocating

Other than the reference to intention, there's nothing there about "deception" or "dishonesty" or any other word for the "seriously bad stuff" that criminalisation would normally be appropriate for. And even intention may have been well-meant rather than predatory, for example as an ancillary provision that collaborators thought was necessary to make a go of some joint venture. There is an out in the legislation for people in that position (it's section 31(1) of the Commerce Act), but what if a court decides, after the fact, that the cartel provision wasn't, in its view, "reasonably necessary" for the joint venture? S31(1) is a pretty slim protection against accidental criminal overreach.

There needs to be a better corralling of cartel criminalisation than currently proposed. We already have a lamentably high rate of incarceration by international standards; we have been too ready to create new ‘strict liability’ offences which penalise people who had no ill intent; we maintain as criminal offences activities which many in society would no longer regard as sanctionable (‘assisted suicide’, recreational use of cannabis); some politicians, partly following overseas examples, have seen electoral advantage in being ‘tough on crime’; and in general, across many issues from commercial failure through to drug use we reach for punitive approaches which fill the prisons, instead of for rehabilitation or prevention approaches which are cheaper, more effective, and more humane.

But all that said, there's still a decent case for criminalising the worst cartels. These are cartels where the intent to cartelise is clear and deliberate; where the behaviour is covert because the cartelists recognise that it needs to be concealed both from customers and local competition authorities; where it is systematic and prolonged rather than an isolated or brief episode; where there are agreed mechanisms for reporting on the cartel’s effects, the distribution of the illicit gains, and disciplining any deviation from the cartel agreement; and where it involves senior members of the cartel companies rather than rogue junior employees possibly not acting at the behest of the company. These are seriously harmful conspiracies, and deserve their own sanction. The first criminalisation case in Australia (see 'The Shipping News') ticked all the boxes.

And quite apart from their conspiracy and deceit aspects, let's not forget the significant economic impacts, including on other (and more honest) businesses who are often the prime victims of these rorts. By far the largest survey available of the international evidence – which covered 700 instances of economic studies or court decisions which looked at cartel price increases – found that

The primary finding is that the median episodic cartel overcharge for all types of cartels over all time periods is 23.0%. It is lower for cartels with solely domestic membership (18.2%), higher for international cartels (25.1%), and highest of all for global cartels (30.4%).

But the proposed law as it stands makes no distinctions, and it should. Ed's solution is as good as any, to split out the especially bad stuff (bid-rigging and "deliberately deceptive" cartels) and leave everything else as is, as a civil rather than criminal offence.

The power of ideas

There's a paper,  'Modelling public expenditure growth in New Zealand, 1972–2015', coming out shortly in New Zealand Economic Papers - it's online already here if you've got access - which has a go at explaining the long-term trends in New Zealand government spending as a share of GDP.

Here's what the data look like.

The paper - by Norman Gemmell (Victoria), Derek Gill (NZIER) and Loc Nguyen (Victoria) - tests out three theories. One (they call it a "public finance" view) says, there is a demand function for publicly provided services like health and education, and expenditure responds to demand changes. A second ("public choice") says expenditure reflects political pressures (eg voters' demand for greater redistribution). And a third ("public administration") says spending follows changes in how the state sector is run. And they find some support for the first two views, but rather less for the third.

I was struck by something rather different when I saw the chart. I thought it demonstrated the immense power of ideas. 

At the start of the period, we're in the heyday of programmes like Lyndon Johnson's 'Great Society' and other attempts to radically improve the scope and the effectiveness of the welfare state. We're in the era of aggressive Keynesian demand management. We're in a world with an expansive view of the commercial activities a government should or could undertake ('Think Big'). 

But by the end of it we've passed through the stagflation that discredited the theory behind the old Keynesian policies. We have new ideas on how cycles develop and what if anything we can or should do about them, with some seeing government as part of the problem rather than the solution. We're more into 'austerity' and leaving ourselves 'fiscal leeway'; privatisation and funder/provider models reflect less ambitious ideas of the scope of government.

The authors, by the way, note (p23) that "past levels of spending strongly constrain future levels – changes in spending demonstrate inertia", and you can see it for yourself just by eyeballing the chart: when it's going up, it keeps going up, and likewise when it's going down (the hump at the end is the GFC and the Canterbury earthquakes, and chances are the otherwise downward trend is still intact). That, in my view, is entirely consistent with keeping on working from the same policy playbook. And I don't think it's any coincidence that the series peaks in the late '80s as the ideas underpinning ever greater state activism got displaced, here and overseas. Our paradigms and models shifted, the policy playbook got reprinted, and the size of government fell into line.

I found myself reminded of Keynes' wording (pp383-4 of the General Theory):

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back...soon or late, it is ideas, not vested interests, which are dangerous for good or evil.

It's also left me wondering - again ('Those who don't know history...') - why economics courses both here and overseas spend so little time on the history of economic thought and on economic history in general.

Now you see it

You want to buy a widget. Bugsy's has the model you want, it's $6. Malone's also sells it, for $5. You may not know Malone's got it cheaper, so you end up paying a dollar too much at Bugsy's.

But suppose Bugsy's and Malone's are required by the Prevent-A-Widget-Ripoff Authority to post their prices online?  With a moment's search you can find Malone's cheaper price. You're a dollar ahead.

But Bugsy and Malone can also now see each other's prices (or at least more easily than they could before). It's possible that Bugsy will reckon he'll never sell another widget at $6 and cut to $5. But it's also possible that Malone will reckon he can safely raise his price to $6 and still share the market with Bugsy.

Which is a long-winded way of saying that compulsory price transparency might or might not be pro-competitive. Generally, you might philosophically lean to the proposition that transparency is a good thing, information asymmetries favouring sellers are unlikely to be good news for consumers, and less opaque markets should work better than murky ones, but there's no certainty you're right.

There's even suggestive evidence that the bad outcome can happen in real life. The petrol market report that MBIE commissioned last year (more detail here and here) noted (p87) that a scheme to make German petrol prices more transparent had backfired:

One study of the German scheme found that prices for petrol increased by between 1.2 and 3.3 euro cents per litre as a result of the scheme, while the price of diesel increased by about 2 cents per litre.

Oddly in this era of big data and far more online shopping, there's remarkably little empirical evidence either way. Step up two Israeli researchers, Itai Ater (Tel Aviv University) and Oren Rigbi (Ben Gurion University), with their paper, 'The Effects of Mandatory Disclosure of Supermarket Prices'.

It's a neat bit of analysis, which is able to use before and after data when Israel's Food Act had made it compulsory for the supermarkets to put their prices online from May 2015. Have a read: it's more or less accessible for the intelligent lay person, while still doing all the econometric heavy lifting (it's differences-in-differences, with fortuitously rich sets of control groups).

Bottom line: transparency turned out to be strongly pro-competitive. Sample results (all from pages 5-6):

after prices became transparent, the average number of distinct prices that a given item was sold for in brick-and-mortar supermarket stores decreased significantly

after the regulation took effect, prices of items in the treatment group [i.e. the supermarkets] decreased 4 to 5 percent more than did the prices of items in the various control groups

prices primarily decreased among chains that are considered more expensive, whereas the impact of the regulation on heavy-discount chains was largely insignificant

prices have declined less in supermarkets that faced fiercer local competition

This empirical analysis suggests that the prices of more expensive and less popular products fell more. We also find that the prices of branded products, that could be compared across retailers, decreased more than did the prices of “similar” private-label products

the reduction in prices is negatively associated with the extent to which customers used the price comparison websites [i.e. the more info consumers accessed, the more the supermarkets were forced to compete]

Interestingly, the very sharp fall in the number of different prices a supermarket charged for the same item across its range of stores - from around 16 different prices for the same widget to around 5 - was, the researchers think, down to the supermarkets' fears of being seen as unfairly ripping people off (p23):

in our setting fairness concerns probably best explain the observed effect on price dispersion ... chains recognized the reputational costs associated with charging different “transparent” prices in different markets

These are remarkable results: a 4% to 5% reduction in supermarket prices is a seriously large payoff, as is the 'fairness' disciplinary constraint on supplier behaviour. I wondered whether 4% to 5% might have been neither here nor there in an Israeli context - maybe inflation is rattling along at 10%, and 4% to 5% gains are lost in the inflationary fog - but not so. Israel's got the same inflation target as we do - 1% to 3% - and has been hitting it. Inflation if anything is below target, with the Economist picking 0.9% as likely for this year. So a 4% to 5% saving is as much of a big deal in Israel as it would be here.

Generalisability elsewhere?  To New Zealand? Who knows. If you were to characterise our supermarkets as a duopoly, then the potential for more transparent competition to deal to potentially fat margins could be large. But on the other hand only two big players increases the potential for (legal) coordination, whereas the Israeli market is more diverse and less susceptible. And it could be that, if it works, enforced price transparency works in some kinds of markets more than others, and I wouldn't want to rush to a one-size-fits-all judgement.

All that said, the Israeli experience rather changes the burden of proof. Before reading it, I was agnostic about regulating for price transparency. Now, I'm more in the camp that feels it's more likely to help than not.

Three cheers for Part 3A

Just before Easter the Minister of Commerce Kris Faafoi announced that New Zealand is at long last going to get ‘market studies’: proactive investigations into the state of competition in sectors or markets to diagnose whether they are operating as well as they might. And, commendably, he’s getting a move on with it, saying that “I have asked officials to fast track this Bill to be operational by the end of 2018”.

It's excellent news. As MBIE's comprehensive Regulatory Impact Statement (RIS) notes (p3), we've been the odd man out: "A 2015 OECD survey of competition authorities found that out of the 62 competition authorities that responded, only New Zealand and Chile did not possess market studies powers". And with our Commerce Commission powerless, "Outside of a few sector-specific regulators, no agency has a specific mandate to undertake proactive activity to promote competition in low-competition areas of the economy, rather than just punish anticompetitive conduct" (RIS, p6, emphasis in original).

And now that we've belatedly got round to it - as the RIS reminds us, all this is in response to a Productivity Commission recommendation from back in 2014 - we've generally done a good job of designing our scheme, which will form a new Part 3A of the Commerce Act. In particular market studies, which we’re going to call ‘competition studies’, will be able to be started either by the Commission itself, or on the direction of the Minister, which is the right approach. As the RIS says (p13), leaving to it ministers alone “could mean that, from time to time, areas of the economy that may warrant a market study  would not receive one".

MBIE is also right to say (p11) that market studies aren’t always about pinging the baddies:

“even a market study that did not identify ways of improving market performance would have benefit in itself, by: 

a. reassuring relevant stakeholders and the wider public that a market is performing well; and

b. potentially avoiding costly and unnecessary government intervention in a market”.

There are a few things I would improve. The Commission or the Minister may instigate a study if, in the words of the Bill, either one “considers it to be in the public interest to do so”, but there is no requirement for them to spell out why they think it is. They are required to spell out the terms of reference and specify when the report will be finished: I think it would be good practice to also say exactly why they’re bothering in the first place.

And MBIE is of the view (p10) that “The Minister would not be required to formally respond to any Commerce Commission study, although in practice it is expected that the Minister would be likely to do so”. I don’t think it’s sensible to use the scarce expert resources of the Commission, and spend the taxpayer’s money, on a study that a Minister could in principle shelve, and you would get better accountability and transparency with a formal onus to respond.

I was also not too sure about MBIE’s final thoughts in its RIS. MBIE thinks (p20) that “it would have a key role in overseeing any market study”: that’s not how independent inquiries by specialist tribunals work. And MBIE “will continue to monitor levels of competition in the economy...is working on establishing a cross-government competition research agenda...[and] will continue to undertake quasi-market-studies itself where necessary, and as capacity permits”. Well, maybe, but MBIE’s own inquiry into the petrol market wasn’t a total success (see here and here), and they’d be better advised to let the Commission get on with the job, at least where competition issues are likely to be the main focus.

As a general and related point, we need to get better at clean lines of responsibility (Commission does this, MBIE does that), and as it happens this new Bill also has an excellent example of our tendency in the competition arena to second-guess and complicate. The Commerce Act has a ‘cease and desist’ mechanism, originally designed to be a quick response to temporarily freeze anti-competitive behaviour and sort out the big bunfight later. But it was hedged about with so many provisos and checks and balances that it was almost impossible to deploy in the prompt way intended, and is now being junked as useless. It was a good idea, strangled. Market studies are a good idea, too: give them to one agency, and leave them to it, and junk “quasi-market-studies” elsewhere.

But enough of the quibbles (though did I mention that this idea was floated in 2014 and it’ll have been over four years before a completely unremarkable feature of overseas competition policy sees the light of day in New Zealand?). This is a very good idea that is finally getting the legislative priority it deserves – well done to everyone who’s assisted along the way.

Next milestone – reform of section 36...