Thursday, 4 July 2013

Business decisions in real life

Just a quick heads up at this point, as I can't really do it justice without having the full paper to hand (it's not yet up on the NZAE website), but I was very much impressed by Miles Parker's paper this afternoon at the NZAE conference on 'Price-setting behaviour in New Zealand'.

And just to be correct on the formalities, could I repeat what Miles said, that the paper was his and not necessarily the views of his employer (the RBNZ).

Miles has gone into the micro data at Stats (i.e. data available at the individual respondent's level, though obviously with the safeguards you'd expect from Stats about protecting the anonymity of individuals' data)  and looked at how businesses actually set prices.

It's hugely interesting. As I said, I'll do it proper justice when the full version is available, but even on the basis of the summarised version that was all Miles could pack into his allotted 20 minutes, it was highly informative and suggestive.

Examples: have you ever grizzled that firms pass on cost increases to consumers, but don't seem to pass on cost decreases? On Miles' data, you'd be vindicated. And if you asked yourself why firms can get away with this, one explanation might be that there isn't enough vigorous competition between firms. If competition were vigorous, businesses' windfall gains from lower costs would be competed away as firms used their lower costs to win more market share by offering lower retail prices. So, implicitly, competition can't be that vigorous after all, which (as I've posted earlier) rather dovetails with Roger Procter's speech to the Productivity Symposium. He argued that in New Zealand there don't seem to be the strong competitive forces that would normally see off companies that tried to hang on to cost windfalls or otherwise continue to coast along without serious competitive threat.

There was indirect confirmation of this from another result in Miles' paper. He had an analysis of the main reasons why firms do not change prices. In the US and the UK, as studies he cited have found, the big reason firms do not change prices is what he called "coordination failure", which translated into plainer English means that firms are afraid that if they raise prices, their competitors won't follow, and they'll be left twisting in the wind. As they should.

In New Zealand, though, that ranked only as the number 3 reason for not changing prices. First was the existence of explicit contracts with customers for a fixed price (fair enough), second was the existence of implicit contracts with customers (customers don't have any formal contract, but they expect us not to rake them over, and we respect that - also fair enough). Those constraints tend to figure highly in the pricing decisions of firms overseas, too, but the point is that in the US and the UK, the bigger factor was what competitors would constrain you from doing. That appears to be less relevant here.

Miles also found that companies in the tradables sector (facing import competition, or facing rivals in export markets) were quicker to change price than firms in the non-tradables sector (who don't have the same degree of competition keeping them honest and sharp-pencilled). However you look at these results, you tend to lean towards too many companies being able to get away with a cushy life, at the consumer's expense.

All that said, it's easy in Godzone to be too hard on ourselves, and I know I've done a bit of it here. So for a bit of balance, I should add that the US economy is famously competitive, and not being quite as dog-eats-dog as many American markets doesn't mean you're hopelessly dozy and complacent. And as it happens, we look pretty good by comparison with the sclerotic Eurozone markets, where prices change markedly less often, and competitors' potential reactions are ignored to a greater degree than here.

Who'd have thought?

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