Here we go again

On August 23 the Aussie Treasurer Dr Jim Chalmers in a joint release with the Assistant Minister for Competition Dr Andrew Leigh announced a new competition review. It's meant to be a rolling rather than a one-off process - "A Competition Taskforce has been established in Treasury to conduct the review, which will be progressed over two years and involve targeted public consultation. It will provide continuous advice rather than a formal report" - assisted by an expert advisory panel including luminaries like the CEO of the Grattan Institute Danielle Wood and ex ACCC chair Rod Sims. Some initial topics have already been identified, including the ACCC's wish list for merger reform (which you can find here) and the prevalence of non-compete clauses in employment contracts.

I'd liked the pro-competition song Andrew Leigh has been singing when I heard him take to the mike at this year's RBB Economics conference: "All good stuff", I'd said, but in a rare moment of prescience I'd added, "whether the rest of the Albanese government shares Andrew's vision of being "pro-growth progressives" remains to be seen".

It's still unclear.  In July Aussie Transport Minister Catherine King decided not to allow Qatar Airways to operate more international flights. The competition review announcement had talked of building on "the Albanese Government’s existing efforts to boost competition" and tackling "cost of living pressures": King's decision, favouring a powerful and highly profitable incumbent, and helping maintain expensive air fares, didn't sit comfortably with either of those aspirations. In slight mitigation, the flight approval system King inherited is a rusty regulatory relic: governments should have been backed out of decision regimes like these years ago.

It didn't help that the ACCC hit the newly protected darling Qantas with a false, misleading or deceptive conduct lawsuit alleging that Qantas had advertised some 8,000 flights for sale that it knew it had already cancelled (press release here, concise statement of claim here). The ACCC chair Gina Cass-Gottlieb is gunning for an all-time-record fine of the order of quarter of a billion big ones. It's only allegation at this stage, but the reputational damage has hit home: as Qantas said on September 4, "The ACCC’s allegations come at a time when Qantas’ reputation has already been hit hard on several fronts", and the Qantas CEO decided to leave two months early. The Aussie government wasn't to know what lay down the pike, but with hindsight I'd guess it is now wondering why it risked supporting an unpopular corporate against the interests of the flying public.

We shouldn't gloat too much on this side of the Tasman when Aussie policies don't line up in a neat row: pots and kettles, for starters, and in any event our interests are best served by having a prosperous well-functioning polity next door, so let's get back to the nuts and bolts of competition policy. 

When I saw the announcement, I wondered why the Aussies were having yet another review - they seem to be on a regular 10-year cycle with the Hilmer review in 1993, the Dawson review in 2003, the Harper review in 2013, and now this one. My first reaction was that they risked a makework reinvention of the wheel - Harper seems like it was only yesterday - but on thinking a bit more about it, maybe they're right. A good example - it cropped up several times at this year's CLPINZ conference - is what, if anything, needs to be addressed if collaborative ventures between otherwise competing businesses are needed to transition to decarbonisation, as they might well be. It's become a more urgent issue now than it was back in Harper's day, partly because in the interim, too little has been done, on both sides of the Tasman, to make enough progress towards our international global warming commitments.

The Aussie "let's have another rethink" approach contrasts with our more piecemeal approach to the Commerce Act. We haven't stood still: within the Act itself, off the top of my head I can think of the new prohibition against anti-competitive grocery covenants in s28A, the change to s36, the provisions in ss48 through 51E on market studies, and the introduction of the whole of the Part IV regulatory apparatus, and outside of the Act we've introduced rafts of ancillary competition-relevant legislation (most recently the Fuel Industry Act 2020, the Grocery Industry Competition Act 2023, and the Retail Payments Act 2022, on top of earlier dairy, electricity and telco legislation). Put that way, the case pretty much makes itself for a reasoned review in the round of where we've got to, how it all works together (or doesn't), and what remains to be done. 

And if we're minded to have a high altitude rethink, I for one wouldn't be averse to a free ride on the Aussies' coattails if they improve their regime to meet the latest challenges. Yes, we're not them, and they're not us, but a lot of the problems are common. We could have saved ourselves several years of expensive navel-gazing if, day one, we'd simply pirated their post-Harper revision of their competition law to deal better to abuse of market power. If they come up with any more bright ideas in the next couple of years let's steal those, too.

Now you see it

Markets need institutions to help them work properly - things like a practically enforceable rule of law, well defined property rights, and the likes of our Fair Trading Act and 'weights and measures' provisions to prevent misrepresentation and deceit and to foster trust in commercial exchange.

All that orthodoxy said, the Fair Trading Act and its companions, worthy though they are, have never greatly floated my boat, and I'm relieved that it's someone else pinging (for example) the back-of-a-truck ratbags selling overpriced tat to poor people.

But during the week I came across an interesting new piece that raised my opinion of the impact Fair Trading enforcement can have. It's from the States, and it looks at the impact of making the airlines disclose the full price of tickets, including all taxes.

By way of background, we don't have rules that require all-inclusive pricing. Back in 2012 when consumer law was being updated, the Commerce Commission argued for all-inclusive pricing to be mandatory, as it is in Australia. MBIE however didn't see an issue, so the Commission's proposal died the death. A pity: I have a lot of sympathy for Consumer New Zealand and its "sneaky fees" campaign. As they say here,

our research shows the problem is real and, with the rise of online trading, looks set to get worse. When goods and services are bought online, we’ve found extra fees may only be revealed near the end of the purchase process.

Not only does the practice mislead consumers, it also makes it difficult to compare prices and gives the retailer an unfair advantage over companies that are upfront about costs. All-inclusive pricing rules would ensure consumers can easily identify the price of a product.

What I didn't know, before I read this American research, was how big the impact of fully disclosing the total price might be.

The paper, published last month, is 'Hidden Baggage: Behavioral Responses to Changes in Airline Ticket Tax Disclosure', and was published in the discussion paper series of the Fed. I came across it, by the way, thanks to the very useful Brookings Briefs which trawl for interesting papers across a variety of issues. Here's what happened.

From early 2012, the US Department of Transportation brought in "full fare advertising rules", or FFAR, which required airlines to show the ticket price including various flight-specific taxes that had previously not been shown until you went to pay. Finding out what those taxes were, by the way, was very difficult in the pre-FFAR regime, assuming you even knew that there were extra taxes and that they varied quite a bit from flight to flight.

On the very large database of  international flights the two authors looked at, the average price was US$750 and the taxes were a sizeable $100, with quite a lot of variation (standard deviation of $45). As the authors show (on pp7-8 and in Table 1) it would have been very easy to pick a flight that looked cheap on a pre-tax basis, but which turned out to be an expensive option on a full-disclosure basis.

And what happened when buyers could see the full price?

First of all, consumers ended up wearing much less of the taxes, and the airlines absorbing much more of them. This is the bit of tax economics known as "incidence", which looks at who actually ends up paying taxes (or receiving subsidies), as opposed to who formally pays them - they can be quite different. You might think, for example, that subsidies to first home buyers will go to the formal home buyer beneficiaries: typically, they won't, and will actually be trousered by housebuilders.

In this case, pre-disclosure, the airlines correctly reasoned that what you can't see or can't be bothered about, we'll dump entirely in your lap. Post-disclosure, consumers were more sensitised, and to keep their custom airlines had to sharpen their pencils and cut their base fares. Or as the paper says (p21)

Three-quarters of every dollar in ticket taxes are thus borne by the airlines in the post-FFAR period, in marked contrast to the pre-FFAR period when  consumers bore the entire tax.

The researchers also found, by the way, that the pattern of pass-through varied with how competitive the route was. If there were lots of competitors (as measured by a lowish HHI index) pass-through by the airlines was higher, which is what theory predicts (low profit margins in a competitive market don't leave much room for sellers to absorb costs in base prices). And it was lower in low-competition markets: "Following the adoption of tax-inclusive pricing ... pass-through rates for unit taxes are shown to drop most sharply in more highly concentrated (i.e. "duopoly") markets" (p28).

Consumers also wised up. Before FFAR, they could see base fares (disclosed), non-tax charges (disclosed) but not ticket taxes (undisclosed). They reacted as you'd expect to the first two (buying less when the cost went up), but paid little or no attention to the taxes, which, as noted, they consequently ended up wearing. Post FFAR, they became sensitised to all elements of the cost:

Adoption of FFAR, however, is associated with significant de-biasing [i.e. responding to all components of costs the same way], such that when base fares, unit taxes, and non-tax charges are all included in total fares in an equally salient [transparent] manner, consumers respond to each equally - consistent with the standard theory of (attentive) consumer behavior (p23, square brackets are my explanation of some of the terminology)

The airlines got hit in a couple of ways. They had to cut base fares to accommodate their new share of the taxes, and were faced by more price-sensitive customers. All up, it made quite a big difference:

The combined impact of reduced ticket tax pass-through and reduced passenger demand (in relation to the portion of the tax still born by consumers) together imply that a $5 increase in unit taxes is furthermore associated with a 2.4% reduction in airline ticket revenue (p30)

As the authors say, "These represent large potential losses in ticket revenue ... and lend strong justification for the U.S. airline industry's intense and persistent efforts to reverse FFAR through lobbying and public relations campaigns" (p26). Best I can tell, a Bill which includes a provision to reverse FFAR has got through the US House of Representatives, but hasn't yet got through the Senate. In Trump's America, though, if you're an airline CEO, you've got to fancy its chances of going all the way.

Maybe the airlines weren't hit as badly as they looked: "it is also possible that carriers may have compensated for lower base fares and ticket revenue through increased reliance on product unbundling and the use of less heavily regulated add-on fees, such as baggage and check-in fees, seat upgrades, in-flight meals and service, etc., whose costs to consumers we do not observe in the ticket data" (p26).

If so, mandating FFAR (and full price disclosure more generally) in New Zealand "should be tempered by the possibility of fostering unintended consequences" (p30) like extra fees for this, that and the other. Me? I'd go for it. These are big bucks being transferred from consumers to producers solely because of off-the-radar treatment. Looks to me as if efficiency and equity point the same way.

As a final thought, it was great to see empirical methods being applied to an issue like all-inclusive pricing. It's all very well running in-principle arguments before Select Committees, but facts are trumps. Big data got by, for example, 'scraping' online prices (as in this paper), are increasingly going to inform what otherwise would be semi-philosophical debates. About time, too.

Where is the market?

What's the geographical extent of a market? And why should we care? And why am I writing about it?

Usually the geographical dimension is a no-brainer: in the case of petrol stations, for example, the Commerce Commission found in its Z / Chevron decision that "the evidence we have viewed suggests that in general the greatest competitive threat is from nearby service stations...The appropriate geographic market differs for each location. On a conservative basis, we have used a 2km radius as a starting point to identify problem areas" (paras 132-3).

In its NZME / Fairfax authorisation the Commission found there were ten separate geographical markets for local newspapers that would be affected by the proposed merger, but a national market for the reach of internet news sites: "as both NZME’s nzherald.co.nz website and Fairfax’s stuff.co.nz website are available and published nationwide, it is appropriate to consider the competition impacts of the proposed merger...at a national level" (para 286).

All very reasonable, all pretty obvious. And you'd think the geographical dimension of a market would usually be one of the less controversial and easier bits of the puzzle.

Why do we care? Two reasons, one economic, one legal. The economic one is that it doesn't matter if a petrol station in Mairangi Bay merges with one in Manurewa. There'll be no competitive effect. And the legal one is that the Commerce Act applies (my emphasis) to a "market in New Zealand": if a market isn't in New Zealand, the Act can't apply to it.

But here's a hypothetical question for you.

Suppose widget manufacturers in New Zealand use specialist widget-moulders made only in Germany. The moulders contain electronic components which need a rare earth, widgium, found only in Zaire. Nobody in New Zealand buys raw widgium. Is there a market in New Zealand for widgium?

Your first reaction could well be, no there isn't. There's certainly no one on the supply side of the market based in New Zealand. On the demand side, Kiwi companies could e-mail Kinshasa, and order some widgium direct, and in that case there would be a market in both Zaire and New Zealand, but they don't, and so there isn't.

But would it change your mind if the Zairean mining companies advertised to the widget makers in New Zealand, saying moulders containing their particular grade of widgium were better than the other guys' (a  bit like those 'Intel inside' stickers on PCs)? What if the local widget makers make up a significant proportion of the global demand (via the moulder manufacturers) for widgium, such that variations in the local moulder demand from widget makers affect the prices the widgium miners get - doesn't that make New Zealand part of the widgium market?

And the reason I raise it is that we may, finally, have had the last word in judicial guidance on how to think about it. It came earlier this month in this case in the Australian High Court (their Supreme Court), and it was (I hope) the last act in the long running air cargo price-fixing cases. And by long running, I mean long running: the events go back to the early 2000s. Plus we traversed exactly the same set of issues, on air cargo services into New Zealand, in our High Court back in 2011: the case is helpfully available here on the Commerce Commission's website.

Hence the analogy: the widget-makers are importers, the moulder makers are airlines, the widgium miners are freight forwarders, and Zaire is the hinterland of various airports in Europe and Asia. Airlines, charged with putting the fix in over various components of the air cargo price (such as fuel surcharges), had said that the only place you can get air cargo services from (say) Frankfurt to Sydney or Auckland is Frankfurt. No market in Australia or New Zealand. End of story.

It didn't, ahem, fly as an argument in our High Court. Three expert economists had backed the airlines' view, two the Commission's contrary view that there was a market in New Zealand. The bench could see the airline economists' argument: the economists had given widgium-style analogies and the court said at [145]

On the basis of such examples, the argument that the market could not extend beyond the place of origin had persuasive force. The way they put it, the market was defined at the moment when the competition for the particular service concluded. In the case of air cargo services that would be when the waybill [the key bit of transaction documentation] was entered into by the origin freight forwarder and the airline.

But it ultimately decided at [182] that

we do not accept the airlines' argument that the geographic location of the market is where supplier/customer transactions for the airline services are physically initiated and agreed. It is not limited to the "factory gate" or in this case the "cargo door"...It extends beyond the cargo door to the geographic locations of the persons whose demands will drive the place and terms of the end contract of carriage. The exporters and importers in those circumstances do not just constitute general upstream or downstream demand. They are the parties whose decisions as to what they want, and how and when they need it, directly drive the service provided by the airlines, with the freight forwarders as intermediary parties.

Oddly, none of this was drawn to the attention of the Aussie judges, who reasoned the whole thing out again for themselves from first principles. They too had seen views all over the place: the first hearing went the airlines' way, the full Federal Court split 2 - 1 in favour of the ACCC over the airlines. As the judgement says at [14]

Reconciling the abstract notion of a market with the concrete notion of location, so that they work coherently, presents something of a challenge. Particularly is this so because "competition" describes a process rather than a situation

In the event the High Court broke 5 - 0 against the airlines. Key bits were, at [32]

The circumstance that the demand from Australian shippers was usually articulated to suppliers in Hong Kong by freight forwarders does not deny that, as a matter of commerce, the interplay of the forces of supply and demand encompassed Australia. That this was so is confirmed by the fact that, as the primary judge found, the airlines pursued sales and marketing strategies in Australia promoting their services to shippers in competition for orders to provide freight for their cargo

 and, at [109]

There were large or substantial shippers in Australia. Those large shippers were regarded by the airlines as not only a potential source of demand, but the ultimate source of demand, for their supply of the air cargo services from ports in Asia to ports in Australia. Certain shippers had particular preferences and were able to influence the choice of airline and flight. As a result, the issue of which airline to use need not have arisen at the port of origin; the decision of the large shippers in Australia was likely to be made in Australia.

In competition economics, you can never say never - you've no sooner tacked down one bit of the carpet than it lifts up in another corner - but with a bit of luck none of us will ever again have to spend too much time over the geographic reach of a market.

Three cheers for the OECD

Some people wonder about the point of the OECD: an expensive talking shop? A rich countries' club? A hand-wringing observer on the sidelines? I'm generally more positive: lots of good ideas and solid research come out of Paris, even if member governments don't always pay them the attention they should.

Which even the OECD itself recognises: here, for example, is a rather sad graph from the handout that came with the OECD's latest Economic Outlook, which looks at how many of the growth-enhancing reforms the OECD has suggested that countries should undertake have actually been carried out.

Conversely, governments can sometimes smuggle policy ideas into the OECD (and the IMF, and other institutions) and can then give themselves the protective cover of "See? This isn't me and my political agenda, this is the international experts talking".

But in any event, I was delighted to see the OECD (prompted or otherwise) picking up on some good ideas about improvements to our competition policy. They're in the OECD's latest Economist Survey of New Zealand, which you can read online here.

First, they've endorsed the idea of the Commerce Commission being able to conduct proactive "market studies" in a well-designed way. As they put it

market studies...would help markets work better, especially when obstacles and distortions to competition are not caused by competition law violations...Clear definition of the purpose and goals of market studies, the involvement of stakeholders, adequate funding and the capacity to demand information (including confidential information) will be important to drive the success of this initiative (p105)

I've been banging on about this for the last couple of years (here and here and here and...) as has the likes of our Productivity Commission. This is an idea that's obvious, simple, desirable, cheap, best practice, and well-canvassed (MBIE's done an exhaustive tyre-kicking consultation), and it's high time for MBIE Minister Simon Bridges to fire the starting gun.

The OECD has also had something to say about our "abuse of market power" legislation (the vexed section 36 of our Commerce Act). It's a bit disingenuous of the OECD to say "The legislative treatment of firms with market power should be reviewed" (p106), since they must know that MBIE's tyre-kicking has included a review of s36: they probably mean it more pejoratively, with a heavy emphasis on the should. In any case they go on to say

Currently, New Zealand's (and Australia's) treatment of firms with market power is unusual. Firms are prohibited from taking advantage of market power only if they are doing so for the purpose of restricting entry, preventing or deterring competitive conduct or eliminating a competitor. Framing the law around intent can be problematic as proving the purpose of commercial conduct has proven difficult for competition regulators. In Australia amending legislation has been drafted to add a mechanism that brings firms under scrutiny based on the effect of commercial conduct on competition (an "effects test") (p106)

There must have been a very funny backroom editorial debate before they settled on our "unusual" regime: "unorthodox" and "idiosyncratic" must have been plausible contenders, but however you phrase it, we're in a policy backwater of our own, and we need to get out of it.

This isn't, to be fair, as much of a walk in the park as the case for market studies: every competition policy regime struggles with these issues. But if the general tone of the OECD's advice is, go the Aussie route with their 'Harper' amendments, I'm fully behind them, for reasons I've also been pushing over the years (especially here, but also here and here and...). Another one for Minister Bridges to put to bed. And he might as well get on with it, as we'd be better off with the Aussie scheme than the European one, which we might end up having to consider if we're serious about the proposed NZ - EU free trade agreement.

There's other good competition stuff in the OECD's report. It says

Other actions to support competition include passing the Commerce (Cartels and Other Matters) Amendment Bill, which would clarify the scope of prohibited cartel behaviour and remove exemptions from the Commerce Act that allow price fixing in international shipping. As argued in previous Surveys, the exemption from Commerce Act provisions for airlines under the Civil Aviation Act should also be revoked (pp105-6)

Totally correct. Why as a trading nation we ever thought it would be a good idea to hobble ourselves with self-inflicted impediments to our freight and tourism is beyond me. It's archaic. Archaic and benign, I quite like: Latin, organ music, stamp collecting. Archaic, inefficient, and anti-competitive, not so much.

Finally, they've got a shopping list of ideas around the Commerce Commission itself, all of which look sensible to me. They've repeated, for example, their previous advice to have "periodic independent assessments of Commerce Commission decisions" (p106). The Commission has been quite good at doing its own, even though some folks (not me) believe it's a waste of space: they say, you can't easily see what would have happened, absent the Commission's decision. It's nonetheless worth attempting, and making it independent would be an improvement.

And they've got various other good governance ideas. "There are no limits", they say on p106, "on reappointment of Commissioners, which is contrary to the OECD's best practice principles. Continuity and institutional memory would be better served through staggered terms for Commissioners and the Chief Executive". As someone who served an, um, unusually long term, I'd have hated it.

But that is why it's such a good idea.

The threat of entry

We've just seen a classic example of how the threat of entry can impose competitive constraint on an incumbent - Air wars: Air New Zealand slashes fares ahead of Jetstar arrival.

In the airline market, it's clear that actual entry on new routes is not far away, but in the extreme case, incumbents might be held in check merely by the possibility of entry, without entry ever actually happening - the theoretical world of the 'perfectly contestable' market, where incumbents perpetually have to keep looking over their shoulder to check that 'hit and run' entrants aren't on their way.

I have to confess at this point that I get little red dots in front of my eyes when people diss the general idea of contestability. Of course it's true that the 'perfectly contestable' market is a straw man, and no regulator or competition authority in their right minds would rely on it when (say) thinking about approving a merger. But equally the general idea of contestability - which for me looks very like the reverse side of the barriers to entry coin - makes sense. My go-to resource, Viscusi/Vernon/Harrington's Economics of Regulation and Antitrust, says (p164) that "the theory of contestable markets is quite controversial", and that's certainly right, but it also says that "if nothing else, contestability has been instrumental in causing antitrust analyses to reduce their emphasis on concentration and take proper account of potential competition". Right on.

Doing so, however, is no easy matter for a competition authority, especially when it comes to the L-for-likely leg of the LET test: "The LET test is satisfied when entry or expansion in response to a price increase or other exercise of market power is Likely, and sufficient in Extent and Timely enough to constrain the merged firm" (from para 3.96 of the Commerce Commission's Merger and Acquisitions Guidelines). It doesn't want to be a soft touch - waving through every merger because it thinks someone or other will turn up sooner or later and compete effectively with the merged entity. As the guidelines say (para 3.98), "The mere possibility of entry or expansion is insufficient". Equally though it wouldn't want to go to the other extreme, either. There will be occasions (like this airlines one) when it can clearly see who's coming, and when, and how much. But there will also be occasions when there isn't a competition problem, even when the authority won't be able to tell exactly in whose colours the planes will be painted.

Isn't it strange, by the way, that every man and his dog can see the immediate and positive connection between competition and good outcomes for consumers when it comes to air travel, yet many of those same people would die in a ditch to stop the same competitive pressures bringing us better outcomes in health or education or infrastructure?

Pssst! Do you want another US$4 billion?

Deregulation of the airline industry is one of the success stories of economics from a number of perspectives (as I wrote earlier here). It's not often that the politicians take the economists' advice, and rarer still when you have well dug-in interests with a previously protected patch to defend, but deregulation of the airline business not only got adopted in the US, and subsequently internationally to a greater or lesser degree, but has worked out exactly as the economists predicted: competition increased, prices fell, choice expanded, more people could afford to fly, and consumers benefitted hugely.

Oddly enough, until very recently nobody had put a figure on the size of the consumer benefits. Step forward Clifford Winston of the Brookings Institution and Jia Yan of Washington State University, who've done precisely that. Here's the Brookings announcement about their results, and if you want the whole nine yards the announcement has links to a longer media summary and to their academic journal article in the American Economic Journal: Economic Policy.

They principally looked at the impact of the "open skies agreements" that the US negotiated with other countries over 2005-09. Their model enabled them to identify the (substantial) declines in price and increase in choice that followed deregulation: it also let them  do the counterfactual "what if" exercise of running the model as if the deregulation had never happened. In that case (I'm quoting from p396 of the journal article)

eliminating the open skies agreements on US international routes that have been signed between 2005 and 2009 would initially raise fares in all segments, with the greatest effect, 50 percent, on business and first-class fares [it was 21% on full price economy and 13% on discount economy]; reduce passenger demand in all segments and market demand [by 13% overall]; reduce the number of flights; and increase the number of carriers per route. Travelers would lose $3 billion annually, nearly $2 billion from higher fares and $1 billion from fewer flights, indicating that they gained substantially from the open skies agreements that had been negotiated during that period. As noted, we are understating the total gains because we cannot measure the additional long-run effects that would increase the initial gains.

On top of the US$3 billion of gains from the 2005-09 agreements, they also found that consumers benefitted by close to a billion dollars more from agreements negotiated before 2000. And they also extended their model to the routes where the US has yet to negotiate open skies agreements, and found that deregulation and competition would yield a further US$4 billion of consumer benefit. And there are still further gains (actual and potential) left uncounted, including the benefits from domestic deregulation in the US and elsewhere, and the benefits of open skies agreements on routes not involving the US.

The numbers show the shabbiness of airline protectionism: pre deregulation, and to this day in some countries, governments had been giving a tiny group of 'flag carriers' - sometimes just a single operator in a country - free licence to rip off their own citizens. It's both stupid and perverse (as I've previously said, here or here).

You'd  think that by now the rort would be too anachronistic to survive:  the process for all the world is as if a medieval monarch were giving his gracious consent to the trade in beaver pelts. These days, it's who is allowed to fly into or out of Shanghai or Manila, but in essence it's no different to Charles I (as I've just read in Peter Ackroyd's Civil War) deciding who should be allowed to make pens, playing cards or spectacles.

Unfortunately governments still seem unwilling to leave the airline market alone, with the latest bunfight being US airlines' allegation that some Middle Eastern airlines are being given unfair competition-distorting subsidies and the US carriers' attempt to have open skies access for Qatar and the UAE rolled back (here's the Economist's article about the issues). The multi-billion dollar consumer benefits of further liberalisation are still going a-begging.

Flying high?

Robert Litan, the Brookings economist who last year published Trillion Dollar Economists: how economists and their ideas have transformed business, has written a short article in the latest McKinsey Quarterly based on ideas in the book. It's called 'Economists: Don't leave home without one'.

One of the examples he gives of economic thinking having an enormous impact is transport deregulation, which started with deregulation of airlines in the US in the late 1970s. Not only have consumers benefitted wildly, but so have businesses. As he points out, the whole clicks and mortar world of e-commerce would likely not have got off the ground:

Had the transportation industry not been deregulated in the 1970s and early 1980s, and had the much more efficient and flexible systems built by companies such as UPS not emerged in response to competition, it is difficult to see how Internet retailers like Amazon, which came along roughly two decades later, would have been able to get started or succeed. Amazon would have had to begin with its own fleet of trucks or even planes to escape the strictures of the pre-1980 regulatory regime, a barrier to entry that almost certainly would have been impossible for new retailers to overcome.

I got to wondering if the deregulation of airlines could be seen in the prices we pay for international air travel, and the answer is, yes it can. Statistics NZ has prices series for air travel that, by happy coincidence, go back to March 1981, a little after the first US push to deregulate prices and the industry more generally. You can see them for yourself if you go to Stats' Infoshare and find your way via the Economic Indicators option to the 'CPI - Level 3 Classes for New Zealand'.

What you'll also find there is the price series for domestic air travel, and the comparison between the international and domestic air transport prices raises, for me, some disquieting thoughts.  Here's the graphical picture: I've rebased everything to 100 in March '81, and added what's happened to prices generally since then, as well as what has happened to the prices of some tradable goods (I've used footwear and new cars. I couldn't find a series for 'all tradables' that went back to 1981, so they'll have to stand proxy for what's happened to tradables more generally). For those who prefer numbers to pictures, there's also a table, where I've shown the average annual rate of price increase over the whole 1981-2015 period, and also, since the high inflation of the 1980s isn't so relevant anymore, over the period since the Reserve Bank Act went into effect (from March '90 onwards).

Some of these patterns were exactly what I'd have expected. Inflation in general has dropped since we - and the rest of the developed world - got our monetary policy act together. And I had expected international air travel prices to show only modest price increases over this period - we've had deregulation, increased competition, the rise of the budget airlines, and technological innovations in both aircraft (larger, more fuel-efficient) and airlines' own administrative systems (computerisation). International air transport prices have indeed risen very slowly over the whole period since 1981, and have actually been falling on average over the past 25 years. Other tradables - cars, shoes - show a similar pattern, where outsourcing to cheaper places in the developing world has played a large part, but international air prices have fallen even faster, and you'd have to think that the deregulatory process was one of the more important moving parts. Litan was spot on.

But then you come to domestic air transport prices, which show - to me at least - a disturbingly persistent pattern . Over the entire period, prices have risen a little faster than inflation as a whole, and over the lower-inflation post-Reserve-Bank-Act period have been rising considerably faster.

And that's rather odd, because some of the reasons that non-tradables inflation tends to be higher than tradables inflation don't apply to domestic air transport. True, you can't easily substitute an overseas product for a domestic one, just as you can't easily outsource your doctor's visit or your kids' secondary school to Vietnam or the Philippines: an ultra cheap fare between Dublin and Nice is no good when you want to go to Dunedin. On the other hand, another big reason why non-tradables tend to rise in price relative to non-tradables - it's harder to achieve the productivity gains you get in (say) manufacturing computer equipment because you can't suddenly make brain operations happen in a quarter of the time - doesn't apply. You'd think a good deal of the increases in aircraft and airline system productivity should have fed through to more modest rises in transport prices than we've seen.

So why didn't they? Much of the answer must lie in the smaller degree of competitive pressure that non-tradables like domestic air transport must face. In saying that, I recognise that there is some degree of domestic competition in air transport. Like everyone else I'm pleased to have snapped up some very low prices from time to time: on occasions, the cost of flying from Auckland to Wellington has been less than the cost of a return taxi between the North Shore and Auckland Airport. On average, however, the cheapies have not compensated for progressively higher airfares overall: in real terms, relative to the overall CPI, domestic prices are slightly higher than they were in 1981. International air travel prices, in real terms, are hugely lower. The numbers wobble around a bit, but you're paying a quarter or a third of what you would have paid back in 1981.

And I suppose there may be some good operational reasons, other than competition playing too weak a disciplinary role, why the domestic airlines haven't been able to match the falling international prices. They don't, for example, have the access to cheap secondary airports that the budget European and American carriers do: perhaps their fares have to reflect the market power of the airports. Or perhaps they've been lumbered with higher regulatory costs than your typical overseas operator. 

But you're still left with the feeling that competition isn't restraining local air prices as well as it might. It might be a coincidence, but the only time that domestic air price inflation lagged behind CPI price inflation as a whole, as you can see on the graph, was in the late '80s and through most of the '90s - precisely the period when Ansett New Zealand was most active.

Wings clipped. Good

On Tuesday the ACCC said it was minded not to allow a proposed coordination agreement between Qantas and China Eastern on the Sydney-Shanghai route (media release here, full draft decision as a pdf here).

Good. It was hard to see how they could find otherwise as the likely detriments were large and the benefits (though real) small in comparison. As the Summary of the decision noted

Qantas and China Eastern had a combined share of capacity (seats flown) on the Sydney – Shanghai route of 83% over the 12-month period from October 2013 to September 2014

...the ACCC considers that Qantas and China Eastern are the major carriers on the Sydney – Shanghai route and each other’s closest competitors. The competitive constraint they impose on each other is likely to be lost if the Proposed Conduct proceeds.

For these reasons the ACCC considers that the Proposed Conduct is likely to result in significant public detriment. It is likely to give Qantas and China Eastern an increased ability and incentive to unilaterally reduce capacity, or limit growth in capacity, relative to that which would occur in the absence of the Proposed Conduct, thereby allowing the Applicants to increase airfares on the Sydney – Shanghai route

The ACCC considers that the Proposed Conduct is likely to result in a range of public benefits. However, the ACCC considers that the magnitude of these benefits is likely to be limited.

The ACCC considers that on the Sydney – Shanghai route the extent of the reduction in competition, and associated public detriment, is likely to be significant and outweigh any benefits of the Proposed Conduct.

The airline industry, left to its own devices, can be too clubbable by half, and there's a very strong argument for regulators outside the industry, like the ACCC or the Commerce Commission, to be an arbiter of proposals like these: we need someone to take the pro-consumer, and not just the pro-industry, line. I don't know exactly what "regulatory approvals" Air New Zealand says it needs for its proposed coordination with Air China, but I hope they include our competition authority.

The benefits of competition, from a guy who's been there (and everywhere else)

The veteran travel writer Jim Eagles has a piece in today's 'Travel' supplement to the Herald (I've searched the Herald's site, and elsewhere, but it doesn't seem to be online*). It's called 'Living in the golden age of flight': those of us with our knees squashed up under our chins in cattle class might jib a little at the 'golden age' description, but Jim's bang on with the gist of his piece.

After recounting consistently bad experiences with the high fares and bad service on monopoly airline routes, and the much lower prices and better service from low cost airlines in more competitive markets - "Even Ryanair, which has a rather mixed reputation, provided a vastly better experience than the last time I made the mistake of choosing BA for European flights" - he gets to his punchlines.

"It all goes to confirm for me, what a wonderful thing competition is...Now every carrier knows that if it doesn't perform the customers can and will go elsewhere. When Air New Zealand (and its parent NAC) had a monopoly on domestic routes the service was shoddy and expensive. Now, thanks to the arrival of competition, it is a superb airline...It's a miracle".

Ten competition economists or a hundred competition lawyers* couldn't have put it better.

* Update June 19 - it's now available here
** A non-random ratio

Level airfields

I don't normally have a lot of sympathy for incumbents with large market shares, least of all for ones who have a long history of looking for and getting sweetheart regulatory protection from their governments, and airlines are amongst the worst serial offenders: I've blogged before about How governments rort their own countries' airline passengers, and have asked Is this the world's stupidest economic policy? when protectionist Aussie regulation means potential competitors to Qantas have to get the Aussie government's permission to expand capacity.

And yet. In fairness to Qantas, there's some justice to its complaint that in some respects at least the regulatory landscape is tilted against it. It's certainly ironic, since Qantas (and many other airlines) are recidivist exploiters of their regulatory environments, that regulation has blown up in Qantas's face. But it has. And it's possible that Qantas has other regulatory advantages in its backpack, unavailable to its competitors, that outweigh the grief the Qantas Sales Act 1992 is causing it. Even so Qantas, I reckon, has a decent case to make.

The Act (brought in when Qantas was privatised) creates two problematic issues
.
One is ownership. The Act has limits on total foreign ownership (49%), on ownership by foreign airlines (35% in aggregate), and on ownership by any one foreign airline (25%). That contrasts with the ability of Virgin, Qantas's domestic competitor, to pick the pockets of three government airlines (the UAE, Singapore, and our own) when it needs money for investment.

The other is operational. Qantas can't outsource the bulk of its international operations: s7(1)(h) of the Act says Qantas's articles of association must "require that of the facilities, taken in aggregate, which are used by Qantas in the provision of scheduled international air transport services (for example, facilities for the maintenance and housing of aircraft, catering, flight operations, training and administration), the facilities located in Australia, when compared with those located in any other country, must represent the principal operational centre for Qantas". Its international competitors can organise their international affairs more efficiently, while Qantas is forced to employ a local workforce who are relatively expensive in the first place, and more expensive again because they've managed to build some of the benefit of this (and other) regulatory protection into their terms and conditions of employment. Qantas might think it's smart every time it gets some regulatory protection, but the reality is that the benefits of protection don't all flow through to the corporate bottom line: they get hijacked along the way by the likes of the pilots and the baggage handlers.

I'm not saying that all the problems that Qantas has are down to not getting a fair suck of the regulatory sav. When you find that you can lose 5,000 staff out of a total of 35,000 or so, you haven't exactly been on top of the cost control game (even accepting that Qantas hasn't had a fully free hand on what it can do), especially as 1,500 of those are apparently in back office management roles. And I just don't understand Qantas's core commitment (which you can find for example listed as a strategic priority on p5 of the company's Data Book) to a "profit maximising 65% market share". Maybe the financial models really do suggest you maximise profits at 65% of the market. Or maybe the real game is to protect market share, irrespective of its profitability consequences.

What I am saying, though, is that fair is fair, and if there are regulatory anomalies that have left Qantas disadvantaged, they ought to be remedied.

Of course, there are two potential ways of doing that. The self-evidently preferable one is to stop hobbling Qantas, and deregulate. The other is to hobble everybody more equally.

I wonder how it will play out: fewer market distortions, or more?

A flight of fancy

As I mentioned last week, I said I'd start to have a look at the submissions various parties have made to the Productivity Commission on our regulatory institutions and practices.

Air New Zealand wants to escape from the ambit of the Commerce Commission and be primarily regulated by the Ministry of Transport, because the airline business is allegedly different to others ("international aviation is a unique market operating outside the normal influencers of a domestic economic or consumer environment") and the Ministry knows the scene best ("The Ministry is the national centre of expertise in international aviation and is the incumbent authority for alliance approvals").

On the other hand it wants precisely the opposite to happen to the airports. They should be taken out from under the shelter of the Airport Authorities Act ("permissive legislation designed for a time when airports (and indeed airlines) were state-owned and operated and therefore allows airports to ‘set prices as they see fit’") and policed more toughly by the Commerce Commission ("the light handed regulation of airports has failed and heavier handed regulation is required. Air NZ advocates the use of the negotiate / arbitrate provisions from the Commerce Act").

Good luck keeping both those balls in the air, lads!

How governments rort their own countries' airline passengers

A while ago I had a go at the protectionist stupidity of typical bilateral inter-government airline agreements, as instanced on this occasion by Cathay Pacific having to get the Australian government's permission to increase the number of flights it would like to make between Hong Kong and Australia.

More recently I've come across some research documenting just how much of a dead hand these agreements tend to be, and how much more airline traffic would be enabled by having more liberal arrangements.

The research is "The Sky Is Not Flat: How Discriminatory Is the Access to International Air Services?", by Roberta Piermartini and Linda Rousová (American Economic Journal: Economic Policy 2013, 5(3): 287–319, http://dx.doi.org/10.1257/pol.5.3.287).

First of all, some facts. The authors have gone through a huge database of 2,300 air services agreements. These agreements tend to be quite illiberal in their provisions.

On pricing, for example, the authors say (p291) that "The most restrictive regime is that of dual approval, whereby both parties have to approve the tariff before this can be applied. The most liberal regime is free pricing, when prices are not subject to the approval by any party". Of the 2,300 agreements, fully 1,625 require dual approval, and only 381 allowed for free pricing.

On capacity ("the volume of traffic, frequency of service, and aircraft types"), again the authors note that there is a menu of potential options - "Ranging from the most restrictive to the most liberal regime, three commonly used capacity clauses are: predetermination, Bermuda I [don't ask], and free determination" - and again the data show the more illiberal terms being adopted. Predetermination and "other restrictive" provisions were adopted 1,446 times, while free determination and "other liberal" were adopted 327 times.

The authors come up with an index that measures the overall degree of liberalisation of airline services agreements, and on that basis they find (p294) that "Overall, existing agreements provide a limited degree of liberalization of the aviation market. Approximately 75 percent of agreements are very restrictive...Very few agreements introduce an intermediate degree of liberalization. A high degree of liberalization ...is reached...only in 15 percent of country-pairs. This is mainly because of the liberalization of air services among countries within the EU".

It's not always you find the folks in Brussels on the right end of the deregulation spectrum, so chapeau! to the Eurocrats on this occasion. And boos and hisses to governments elsewhere, who to a greater or lesser degree have been colluding to prevent their own consumers (households and businesses) from getting the quantity and pricing of airline services that they should be enjoying.
Because that's what the second leg of the paper establishes: less liberal agreements prevent traffic, more liberal agreements enable it.

"Following the traditional approach of measuring the degree of liberalization by means of an index", they say (p310), "we find strong evidence of a positive and significant impact of the degree of liberalization of the international aviation market on passenger traffic. In particular, we estimate that increasing the degree of liberalization from the twenty-fifth to the seventy-fifth percentile increases passenger traffic by approximately 18 percent. This effect is shown to be robust" (to various potential statistical problems).

And that's what you get, folks, when your enlightened elected representatives put producer interests and "national champion" policies ahead of the consumer's interest.

Oh, and apart from their grotesquerie from an allocative efficiency point of view, did I mention these policies are inequitable as well? Because guess which countries' airlines tend to get least access to world aviation markets? Let's see now - would it be the low and middle income countries? Why, yes it would.

Is this the world's stupidest economic policy?

I read in this morning's online Sydney Morning Herald, under the headline "Cathay wants more flights Down Under", that "Cathay Pacific wants to increase services to Australia but first needs the government to lift the cap on the number of flights it can operate here. The airline has hit its limit of 70 flights a week between Australia and Hong Kong, as allowed under bilateral air rights".

There are no good reasons for this "you'll only fly if we say so" policy, and many bad ones. It's protectionist, anti-consumer, anti-competition, anti-enterprise, anti-innovation, antediluvian - have I left anything out?

It's hard to believe that this sort of thing still persists. It's 35 years now since the US deregulated commercial aviation: when Alfred Kahn, the architect of the US move, looked  back on the outcome of the deregulation, he said (and I'm quoting from his Wikipedia entry here) that "The industry in the last 30 years gave the public something it had not received before: high quality, space, and low cost. It catered to a variety of demands and abilities today so that we had an enormous spread of fares. It offered the people upgrades such as business class and frequent flyer miles".

Rather endearingly, Kahn also said (again cited in the Wikipedia piece), "I can't tell one plane from the other. To me, they're all just marginal costs with wings."