The ComCom session at the NZAE conference

Last week the New Zealand Association of Economists hosted a Commerce Commission themed session at its annual conference. It's become a fixture in the past few years, I'm pleased to say, after a drought period where industrial organisation, competition and regulation didn't quite get the focus they deserved.

The Commerce Commission team - Diego Villalobos, who chaired the session, Geoff Brooke and Rae Rho - talk about productivity trends in the regulated electricity lines business, the regulatory cost of capital, and the competitive effect of new unmanned petrol stations

Geoff Brooke's presentation showed the large increases in allowable revenue for the electricity lines businesses (ELBs) which the Commission has proposed for the forthcoming 5-year regulatory period (from the Commission's draft decision). They're stonking great rises - more than a billion dollars extra in what makes up about a quarter of a household's electricity bill - and they add to all that upward pressure on domestic non-tradables prices that is already giving the Reserve Bank conniptions.

But they're justified, as you can see in the graph below which shows the underlying drivers: input cost inflation, a substantially higher weighted average cost of capital ('WACC') reflecting the rise in interest rate costs as ultra-easy monetary policy has changed to the current post-Covid tightening, and provision for increased opex and capex spending.

Diego Villalobos talked about a productivity study that ComCom commissioned from Cambridge Economic Policy Associates (CEPA), and which looked at the productivity trends in the electricity distribution business (i.e. the ELBs again). As ComCom's cover note about the research said, "The productivity of Electricity Distribution Businesses (EDBs), measured as their outputs relative to inputs, is an important performance indicator. Over time, we and other stakeholders expect EDB productivity to increase as they become more efficient and able to deliver the same services using fewer inputs".

Unfortunately the exact opposite has been happening: productivity has fallen, and sharply, as this extract from the CEPA work shows. 'Non-exempt' EDBs in the table are those directly revenue-regulated by ComCom, 'Exempt' are ones owned by local consumer trusts and which are only subject to an information disclosure regime. But either way both groups have shown steadily lower productivity.

And it doesn't seem to be an oddball result of anything weird CEPA has done: Stats NZ data for a broadly comparable sector (electricity, gas, water, waste services, the yellow line in the graph below) show a similar pattern. It's still possible that both CEPA and Stats are missing a trick somewhere along the line - I'd argue that in some sectors of the economy, particularly those closest to the internet and other IT, productivity is being systematically underestimated - but the first best guess looks to be that there is something sector-specific happening.

It would be nice to say we know what's going on here, but we don't. CEPA canvas some explanations in their Section 6, so have a read for yourself and see what you think, but thus far there don't seem to be any smoking guns.

And finally Rae talked about her research on the competitive impact on incumbents of new unmanned petrol stations opening up (full thing here, summary here). Here's her key result. Look at the red dots, which are the price responses from incumbent petrol stations within five minutes' drive when a new unmanned station opens: you'll see a 2-3 cents per litre reduction in the weeks after the new competitor opens. The black* dots are the response by incumbents who are five to ten minutes' drive away: zilch,  nicely demonstrating the geographical market definition for petrol.

As well as this event study examining response to new entry, there was also a cross-section analysis comparing petrol prices where incumbents face at least one unmanned competitor within a five minute catchment: "On average, Regular 91 prices are 6.1 cpl [cents per litre] lower in local markets where at least one non-supermarket unstaffed site is present, compared to those with staffed sites only". 

There was a bit of discussion in the Q&A about whether ComCom ought to go around the country telling local authority land use planners about these results, and encouraging them to free up areas that new unmanned petrol stations could use. Quite right, too: if the councillor for a particular ward would like the credit for petrol becoming 6 cents a litre cheaper for his or her constituents, there's an easy way to help bring it about.

*A correction, I'd earlier mistakenly repeated 'red' again

How's my driving?

At the end of February the Commerce Commission published an interesting "look back" review of what it could learn from how its merger decisions have been made. As the Commission said, "The purpose of our ex-post merger reviews is not to determine whether the original decision of the Commission was correct or incorrect, compared to alternative decisions available to the Commission at the time. Instead, our reviews evaluate key factors of a decision and assess whether the Commission’s predictions have eventuated as expected".

That's fair enough. It's always going to be hard to figure out, with the passage of time, what would have happened (the 'counterfactual') if the Commission had made a different call. That's not to say it's a completely hopeless exercise. It could well be worthwhile at least looking for some (however inconclusive) indications of correctness: post-merger, did prices go up for reasons that weren't obviously related to the likes of input costs? Did innovation slow down? Did consumers see the benefit of the efficiencies the merger claimed to enable? But I accept that you may not get any clearly definitive answers, unambiguously linking the merger to unwelcome outcomes, and in that case the more limited objective of seeing whether you read the winds right at the time may be the best you can do.

And it is well worth doing. For one thing, there's been something of a global pushback against competition authorities that may have been too "soft" on mergers - wrongly seeing, for example, adequate competitive constraint on the post-merger entity when, in fact, there wasn't a realistic prospect of new entry or of expansion by existing competitors. For another, we don't do enough in New Zealand to go back and see if policies and plans and decisions worked out like we thought they would, and if not, why not. And finally it shows a pleasing openness to shed some light on the Commission's processes in an environment when some other agencies have been unnecessarily secretive (eg in their recent round of Briefings to Incoming Ministers) on what the issues are in their bailiwick and what they think about them.

The Commission has, apparently, been doing these post-merger reviews quietly in the background for a while: "The Commission first undertook some ex-post reviews of past merger decisions in 2015 [I'll come back to that one in a moment], focussing on cases between 2011 and 2013. A similar exercise was undertaken in 2016, looking at merger decisions made in 2013 and 2014. The Commission renewed the practice in 2019 with a review of six merger decisions made between 2014 and 2016. This process was replicated in early 2023, looking at merger decisions made between 2017 and 2019". But this is the first time the Commission has officially published its findings, and it covers the six reviewed in 2019 and the seven reviewed in 2023 (although in the end the Commission wasn't able to finish reviews of two of them, so 11 made it through to the final analysis).

The big takeaways? The Commission thinks that market participants are too blasé about the likelihood of new entry/expansion and about the ability and incentive, post merger, of consumers being able to exercise countervailing power, and it's going to be asking for harder (and preferably documentary) evidence on both fronts. And in dynamic markets - where there may be rapidly changing consumer fads and fashions (like tastes in the yoghurt market, in one of the reviewed cases) or where new technologies are being rolled out every other day - it may not make much sense to spend a lot of time on market definition, and it would make more sense to ask, post merger, will the merged entity be better able to get away with bad stuff or will it still face adequate competitive constraint.

The Commission said that this is the first time it has published the findings of these post-merger reviews, and strictly speaking that's true, but the results of the 2015 review are also in the public domain: I wrote about them at the time ('More on entry'). They were given as a presentation at the New Zealand Association of Economists' 2015 annual conference, very likely on the basis of "these are the views of the presenters not the Commission's". Interestingly, it came to similar conclusions about being suitably hardnosed about the likelihood of new entry, particularly where there may be high sunk costs (which might deter a potential entrant if entry were at risk of going pear shaped) or where entry is from overseas (particularly if they have bigger fish to fry than the New Zealand market).

Unfortunately the presentation isn't on the NZAE website (only a short and not very informative abstract), and while it used to be on the Commission's website, it doesn't appear to be now. If you're trying to track it down - I found it as an e-resource on the Auckland Library website, or you may have academic access to the paywalled economics journals - then you're looking for Lilla Csorgo and Harshal Chitale, "Targeted ex post evaluations in a data-poor world", in the 'Special Issue on Advances in Competition Policy and Regulation', New Zealand Economic Papers, 2017, Vol. 51, No. 2, pp136–147. 

Don't forget the benefits

Scrutiny of mergers is on the increase, notably in the US, where new draft merger guidelines have been widely interpreted as a sign of a more activist competition regulator proposing to take a tougher line, but also elsewhere. In the UK, for example, one economist recently wrote a piece in the Financial Times pointing out that the CMA's merger decline rate has been rising in recent years ('The UK’s competition watchdog risks undermining business dynamism', possibly $). 

In this latest swing of the pendulum, it's getting harder to argue for the 'good' merger, where the merged entity produces efficiencies (typically cost savings) or other benefits, such as innovative synergies from a combo that's more than the sum of its parts, or creates a more effective competitor to an entrenched incumbent. And more critics are finding more reasons to ping supposedly 'bad' mergers which reduce competition and increase corporate market power.

By happenstance, along have come two pieces of work, reminding us not to forget the 'good merger' story.

First, two hat tips for unearthing the first piece. One goes to the always interesting 'Blog Watch' column which the University of Canterbury's Paul Walker (aka GrumpyMcGrumpyface on Twitter) writes for the New Zealand Association of Economists' Asymmetric Information newsletter (if you're the proverbial intelligent lay person who'd like some very well-written takes on local and international economic issues, sign up for Asymmetric Information here, it's free). And the other goes to the equally approachable Conversable Economist blog, run by Timothy Taylor. He's also the editor of the Journal of Economic Perspectives, which "aims to bridge the gap between the general interest business and financial press and standard academic journals of economics" and is a terrific explainer in plain (or plainish) English of current economic debates (it's also free to read online, start here). Taylor's 'Recommendations for Further Reading' in each issue are always worth a look.

In his latest (July) 'Blog Watch', Walker picked up on one of Taylor's blog posts in April, 'After that Big Merger, What Happened?'. Taylor had come across some research done by folks at the International Center for Law and Economics, 'Doomsday Mergers: A Retrospective Study of False Alarms'. They looked back at six high profile, highly contested US mergers: their bottom line was that "Our retrospective analysis shows that many of the alarmist predictions of the past were completely untethered from prevailing market realities, as well as far removed from the outcomes that emerged after the mergers". With only one, partial, exception, the mergers had actually been 'good' mergers, with pro-competitive pro-consumer effects, or as Taylor summarised it, the retrospective case studies "do show pretty clearly that dire predictions about ill effects of mergers need to be taken with a few spoonfuls of salt" (he also wondered whether the merger sponsors' claimed benefits were as oversold as the merger critics' claimed costs were, which is fair enough).

The only partial exception was a big merger in the beer industry, where post-merger prices for some of the mass-market beers did increase (average prices remained steady). But that had the happy outcome that it created a profitable opening for the craft brewers, who have taken increased market share. And if you'd had the choice between a now more expensive but decidedly pedestrian beer and a tastily hopped artisan American Pale Ale, you'd have switched, too.

The other piece of research, which I came across on the ProMarket blog, is some work done for the World Bank. The ProMarket write-up is 'Firm Consolidations Hurt Workers, But Likely Not Because of Market Power', and the original all the bells and whistles World Bank working paper is 'Firm Consolidation and Labor Market Outcomes', very short summary here and full pdf here.

The researchers were primarily concerned about the adverse employment consequences of mergers, and they were well placed to investigate them. They were able to use a big administrative database in the Netherlands which contained matched employer-employee data, so they were able to compare what happened to employees in acquired companies after some 1,000 takeovers in the Netherland over 2011-15, compared to what happened at very similar companies that weren't taken over.

It's true that takeovers led to job losses: "There is substantial job loss among the workers of target firms: in the four years after a takeover, workers at a target firm are 8.5% less likely to be retained at the consolidated firm compared to workers in the control firm. This lower retention rate translates into income loss ... These effects are long-lasting and are present even in the fourth year after the takeover" (pp1-2 of the World Bank paper). 

Now, the researchers are, properly, concerned about this long-term adverse impact on those hit by involuntary job loss: my two best answers (which I've championed here before) are, at a macroeconomic level, maintaining as hot a labour market as you can run without triggering inflation, and, at a microeconomic level, 'active' labour market policies that make it easy to retrain, upskill, or go self-employed. Stomping on anti-competitive constraints in the labour market, like non-compete clauses, wouldn't go amiss, either.

But that said, the employment restructurings they are bemoaning are what in the competition policy game we would call efficiencies: they're cost savings, and as the researchers discovered, cost savings of a very specific kind. They found that if lab technician Kath in the acquired company is paid more than lab tech Rita in the acquiring company, Kath tends to get laid off. They also found that if there are lots of accountants in the acquired company, but the acquiring company already has lots of accountants, too, then the acquired accountants tend to get laid off. 

It makes complete sense, and it's likely to be a ubiquitous feature of mergers everywhere, not just in the Netherlands: if you were running the acquirer, you'd very likely act on similar lines. It's hard on Kath, and hard on the accountants, but the merged entity ends up more productive. And that's without thinking of any other efficiencies that may be on the table. Sure, for competition policy purposes, it's the net outcome that matters, and in any given case efficiencies may well be outweighed by detriments, but it would be silly to start from a viewpoint that efficiencies are nebulous or unlikely. A better starting presumption is that there are very likely to be at least some.

The Dutch example also got me thinking about what the New Zealand data might show. The Netherlands may well have a good administrative database, but so does New Zealand: indeed I'd hazard a guess that ours is top tier by international standards. Formally, it's the 'Integrated Data Infrastructure', or IDI: Stats calls it "a large research database. It holds de-identified microdata about people and households. The data is about life events, like education, income, benefits, migration, justice, and health. It comes from government agencies, Stats NZ surveys, and non-government organisations (NGOs). The data is linked together, or integrated, to form the IDI. The IDI complements the Longitudinal Business Database (LBD), which holds linked microdata about businesses. The two databases are linked through tax data".

At one point, access to the IDI was overtightly corralled, and not enough was being done to exploit its potential value. Now, it's being increasingly mined to good purpose: this year's NZ Association of Economists' conference featured a variety of IDI-based projects. AUT's Gael Pacheco and her team, for example, were able to follow (anonymised) Kiwi students who had done badly on the international PISA tests of numeracy and literacy to see what their subsequent employment, health, and justice system outcomes had been (as you'd expect, not good).

So why hasn't someone had a look at the effects of takeovers? It's all very well for supporters of mergers to claim benefits, and critics to claim costs, and the Commerce Commission to appeal to first principles of economics, but wouldn't we get more informed decisions if the question was, how does this proposed merger line up with what we empirically know about New Zealand mergers in general?

A statistical surprise

The New Zealand Association of Economists runs a poster competition at each annual conference - a good idea, encouraging concision and clear messaging, not always a forte of economists - and this year it was deservedly won by Alexandra Turcu of AUT's Work Research Institute, with her entry, "Underutilisation in the New Zealand labour force: Unused human capital, or an underpaid workforce?". The winner's decided by popular vote of the attendees, and I voted for it, too.

Before reading it, and (I'd guess) like everyone else, I'd always assumed that the "underemployed" were available to work more hours than they currently are, and were a reserve slush fund of unused labour availability. But Alexandra discovered something striking about the apparently "underemployed". 

She looked at the characteristics of two kinds of underemployed people - the full-time underemployed (full-time; available to work more; want to work more) and the part-time underemployed (part-time; ditto; ditto). Remarkably, she found that "Although the underemployed groups want to work more hours, and state that they are available to do so if more hours were available, our results reveal that they already work a similar amount to their fully utilised counterparts. The fully-utilised work only one hour more than the underemployed do per week": full-time employees, for example, who said they were "underemployed" were actually working 40 hours a week, virtually the same as the 41 hours of fully employed full timers, and it was the same story with part-timers where the "underemployed" ones were putting in 15 hours a week compared to the 16 put in by fully utilised part-timers.

So it is not at all obvious that these people actually form any substantial pool of increased labour supply - an important thing to know if, for example, you're the Reserve Bank wondering about potential output and full employment - and it's likely that what they're telling Stats has less to do with their availability to put in more hours and rather more to do with their relatively low incomes. As Alexandra put it, "This begs the question: Are underemployed workers truly underemployed, or are they just underpaid? When asked why they were underemployed, the majority of respondents said it was because there was not enough work available. However, it is important to note that the HLFS [household labour force survey] survey did not include "not enough income" as a potential answer".

So one practical lesson to take away is that there is less slack in the labour supply than you might have thought, if you had been relying on those apparently "underemployed" being available to step up to the plate and do more work. And if you were concerned about their low incomes, there's a positive to take away: fully 57% of those "underemployed" part timers transitioned into fully utilised full timers in the following quarter. They don't sit on the sidelines for long.

Here's the full poster.