Here's a revolutionary idea

There's an ongoing barney on social and mainstream media about what the latest poor numbers for business confidence might or might not mean, and, in that unappealing Kiwi way, who's to blame. The truth is, we're all reduced to guessing what goes through the minds of the people who fill out the survey forms and bung them back to the ANZ and the NZIER.

My conjecture - an upmarket way of saying 'sort-of-informed guess' - is that it's actually a mix of several things. There's probably an element of party politics in it, though as I said the other day, it looked to me as if the business community had got past the toys-out-of-cots stage. There's probably an element (beyond partisan) where they've looked at government policies and think they're bad news (irrespective of who introduced them). There's certainly concern about pressures on profitability, where there's pretty obvious evidence of costs pressures that aren't easy to pass on to consumers.

But do I really know? Does anyone?

So here's my revolutionary idea. Why don't ANZ or the NZIER ask, what's bugging you?

And here's the template. It's from NAB's latest quarterly survey of Australian businesses.

That's not hard, is it? You could ask the same questions here, word for word, and you'd be left with as clear an answer as the Aussie survey shows.

Just before I let go of this business confidence thing, could I say to all those talking up and talking down the 'confidence' figures, confidence readings are kinda interesting in their own right, but you're both paying them far too much importance. The links between 'confidence' and actual business outcomes aren't always that strong.

But don't extrapolate from that and say, business surveys are airy fairy indicators of nothing in particular. It is - and you can't say this terribly often in economics - beyond reasonable question that some of the measures in these surveys, particularly the ones related to firms' own prospects, have very strong links to reality. You might think a simple 'getting better/getting worse' question isn't going to get you very far. But it often will, which is why even official statistical agencies run them. 

Here, just to belabour the point, are the latest results from the French statisticians.

And to belabour it into the ground, here is the link between Aussie GDP and the 'Performance of services index' compiled by the Australian Industry Group, which is again based on the balance of better/worse answers.

And, finally, here at home here's how a combo of some of the business and consumer measures in the ANZ business surveys track against our GDP (it's a graph in the latest one). It's a pretty good relationship. It helps too that it is timely, and a leading indicator of what's down the track (the graph shows a five month lead between changes in the indicator and subsequent changes in GDP).

So for all those knocking business surveys because it suits them tactically - give over. These are useful, cheap, timely and while not every bit of them is always telling you useful stuff, in parts and in combo they give reliable readings on where we are and where we're going. If the evolution of the economy, good or bad, is giving you political conniptions, don't shoot the messengers.

New thinking

Brining turkeys, looking after Christmas guests, and wrapping up the last bits of the year's consultancy work have eaten up my time, but I'm finally getting round to writing up the excellent Asia-Pacific Industrial Organisation Conference held at the University of Auckland earlier this month.

This was only the second time it's been held - as explained here it's a new initiative to add a regional industrial organisation event to the big American and European ones - and it's already attracting some big-name speakers and a good attendance. Over the next three years it will be held in Melbourne, Tokyo and Singapore. Nice to see our local academics presenting too: from AUT, Richard Meade (finance) and Lydia Cheung (mergers and divestments), and from the University of Auckland Simona Fabrizi (asymmetric information, and again on innovation), Erwann Sbaï (auctions), Tava Olsen (incentives) and Steffen Lippert (learning and entry).

It was heavily academic-focused, with a smattering of regulators and economic consultants, so you had to be prepared for a fair amount of pure economics theory, but then if you're at this sort of conference you'll probably comfortable feeding your inner quant. As always with the fancy models, some are down the cleverness-demonstration end, and some are analyses of well-off-the-beaten-path esoterica. But it's worth sitting through the sessions, because it's conferences like this that can present the path-breaking innovations - in ten years' time, they'll be the standard way we think about issues like two-sided markets, platforms, auction and market design, vertical integration, or oligopoly (which were all session topics at the conference).

My own bent leans towards empirical applications of the new ideas, so I especially enjoyed the first keynote presentation. Harvard's Ariel Pakes presented on 'Just Starting Out: Learning and Equilibrium in a New Market' (there's a recent version here). The new market was the UK wholesale electricity market for 'frequency response': Ariel's modelling showed how the players learned how to play the new game, and showed that they got pretty good at it reasonably quickly, with an end-result, once they'd got their heads around it, that was close to an efficient competitive outcome.

This is the sort of market where you might have expected strategic behaviour, and early on there were  indeed high bids which looked like invitations to follow. In the event tacit or other collusion didn't happen: I asked Ariel why, and the simple answer was, too many competing participants for it to hold (29 in all, with the top 10 holding 84% of capacity and an HHI of 1100). The paper says that "One area where [this kind of] learning model may be particularly helpful is in simulating counterfactual outcomes, a type of analysis increasingly used by regulatory authorities", and that's true: I'd also like to see it applied to things like our wholesale electricity market.

The other keynote was Columbia's Yeon-Koo Che on 'Optimal Sequential Decision with Limited Attention', which at first glance sounded like it didn't compete with the alternative option of a late breakfast. But it was excellent (there's a version here), and witty: his general theme was how people make decisions when they have a finite budget to spend on verifying their assumptions, and one of his examples included how people should select the media they read in a world of highly partisan "fake news".

I took two things away. One is that when you aren't especially sure about the likelihood of something, you should look for corroborative evidence, but when you're pretty confident about its likelihood (or unlikelihood), you should look for contradictory evidence. Whether that's a Great Universal Law that applies in all circumstances, I don't know, but it makes intuitive sense. And the other was that sometimes longer deliberation leads to worse decisions, something that ought to be bludgeoned into the brains of some of our policy-making and law-making institutions.

I lucked into a particularly good choice from the parallel session menu, on 'Topics in empirical IO'. Lawrence White (NYU Stern Business School) challenged the conventional wisdom that the US economy has become more concentrated (in an HHI sense). Ken Krechmer (University of Colorado Boulder) showed how control of standards (eg on how mobile phones communicate) matters for international trade and for potential use of market power. And Stephen Martin (Purdue) went into utility theory and how compensating losers with gains from winners mightn't be as easy as it looks in the textbooks: one implication was that price discrimination might turn out more welfare-reducing than usually thought.

My own contribution was to moderate the panel session, 'Big data: friend or foe of competition and consumers?', with panellists Reiko Aoki, Commissioner at Japan's Fair Trade Commission, Reuben Irvine, acting chief economist on the competition side of the Commerce Commission, and Greg Houston, principal at Australian consultancy HoustonKemp (and who kindly sponsored both the session and the overall conference).

We'd agreed to take a bit of a risk. After Greg had presented some results showing how big data can be used to  better refine geographical markets and to show the impact of new app-based services like Uber on older economy sectors like taxis, we left a good half of the time available for discussion, hoping that enough people would come along and be prepared to have a conversation. And fortunately they did.

Greg starting his presentation

The panel ready to take questions

UCLA's John Asker in the discussion, with Harvard's Ariel Pakes and Duke's Leslie Marx (co-author of the excellent The Economics of Collusion) in front

Broadly we came down on the side of more friend than foe: we (and the attendees) could see a lot of potential for society from better and greater use of the flood of modern data, ranging from better services for consumers and epidemiological and other payoffs from combining diverse datasets through to, for regulators, more accurate market definitions and clearer observation of market behaviour. But - and this was a recurrent theme - it wasn't obvious that regulators could tap into the best econometric experts at will: it's hard, especially in the US, to prise them off the beaten academic path. And the difficulties of cleaning, interpreting and manipulating databases in the terabytes are easily underestimated.

We weren't completely Pollyannas - we could see the potential risks in collusion between pricing algorithms, for example; we recognised that databases can create market power; and we had a range of conviction about whether traditional enforcement analysis and legislation are up with the New Economy play - but broadly we were technology and data optimists.

For those interested in the topic, we compiled a short reading list: a good place to start is the Competition Bureau of Canada's discussion paper (which Reuben had tracked down). And here's a copy of Greg's slides.

Well done to the local conference organising committee - Simona Fabrizi, Tim Hazledine, Steffen Lippert and Erwann Sbaï.

That touchy-feely stuff

Life's too short, and you can't do everything, and one of the things that fell off my radar for a while was Masterchef. Lately, though, I've caught up with it again (the 'professionals' series), and I've found it as compulsively watchable as ever.

But I was struck by something that goes beyond cooking.

People aren't used to getting praise.

Especially in the early rounds, where you've got people who haven't yet climbed into the higher branches of the professional tree, you can see that they've had little or no positive feedback at all in their careers.

A kind word from any of the judges, and you have some contestants going all teary-eyed. They've rarely had people in their professional lives tell them they're doing a good job.

And it's not just a  bit of recognition from Michelin-starred Marcus Wareing that's got people going all gooey. Sure, you might be a bit overwhelmed, too, if the big guy in your line of business said you were pretty good. But a bit of appreciation from Gregg Wallace (whose autobiography is well worth reading, by the way) or from Monica Galetti will do it too. You can see that praise has been thin on the ground for the contestants, even though - almost by definition given that they've entered this competition - they're talented and motivated people.

And it got me thinking about the poor business culture we've created. There's little or no leeway for making mistakes, there's a very low tolerance for risk (manifested, for example, in businesses' very high 'hurdle rates' for investments), there's bugger all appreciation of the difficulties of making decisions under uncertainty (the RBNZ in particular tends to get it in the neck, as I've argued), and hence or otherwise there's a focus, and with 20:20 hindsight at that, on shortcomings and blame.

You ever been through one of those corporate 'performance reviews'? "Well, I see you had 12 KPIs for this year, and you've achieved ten of them. Now, let's talk about those other two, shall we?".

Some companies are finally getting the gumption to dump the damn things, as you'll find in this fine Harvard Business Review article, 'The Performance Management Revolution'. Two brief extracts: it concludes by saying that

Performance appraisals wouldn’t be the least popular practice in business, as they’re widely believed to be, if something weren’t fundamentally wrong with them

and earlier says that the something fundamentally wrong thing is

With their heavy emphasis on financial rewards and punishments and their end-of-year structure, they hold people accountable for past behavior at the expense of improving current performance and grooming talent for the future, both of which are critical for organizations’ long-term survival 

I wouldn't usually bother wandering into management theory, except that I can't help feeling that poor management practices are part of our long-standing productivity under-performance. A while back I posted about some research which found that

43.5% of the productivity gap between us and the [United] States is down to our relatively weak management capabilities (and it's interesting that Australia, with a somewhat similar business environment to ours, comes out with a similar number, at 45%)

What I didn't add at the time, but Masterchef  has now prompted me to, is that, in turn, a lot of our relatively poor overall management practice is down to bad performance management and really bad people management. As this paper found, "People management is the weakest area for New Zealand manufacturers with the country ranking fourteenth among [seventeen] participating countries". Here's what the data looked like.

Other than on the terraces at the game, or after a few jars, we don't do that inspire-y motivation-y gooey praise-y thingy. We tend not to open up, and especially not if it risks being a bit confrontation-y. Look how we score (below) on 'addressing poor performance': by international standards, we just don't want to go there. 

Everyone, this election year, seems to have a list of policies that might help turn our productivity around: the New Zealand Initiative came out with one the other day, to mixed reactions. So here are two more from me.

The less important one is, Fred in Sales and Wilma in HR have been a drag on the business for years. You know it, their colleagues know it, and you've let it drift. Fix it.

The more important one is, focus on what people have been doing well. Let them know, and help them get even better. There aren't huge numbers of win-win policies, but praising a job well done not only makes people happier, but the research shows it improves personal, business and national performance.

Getting the most out of economists

We had a session at last week's RBB Economics conference in Sydney on "How can a Chief Economist's team enhance competition law enforcement? - an examination of different approaches", with a panel made up of people who should know: Lilla Csorgo, chief economist on the competition side of our Commerce Commission; Graeme Woodbridge, chief economist for the whole caboodle at the ACCC; and RBB partner Derek Rydiard to talk about the European Commission's experience.

One conclusion that emerged was that competition authorities had experimented over the years with various internal structures, ranging from a separate 'consultancy on call', through the EC's model of an internal quality check unit, through to integration in (or at least close involvement with) the investigation teams. Of the various models, integration with the investigation teams, or, at a minimum, close and early involvement with the cases at hand, seemed to be working best.

That didn't surprise me: much the same evolution has been happening in the private sector. Groups of economists, lurking away from the main business of the company in some side-alley of corporate HQ, used (amazingly, in retrospect) to be quite common in the banking world, for example, but got shook out in the 80s and 90s, and rightly so. Employers understandably wanted to know exactly what value-add the economists were bringing to the party. I remember one exercise where I had to go round the various operating 'line' divisions and get them to contribute their share of the economics budget (which they did, by the way): it was quite a good mechanism to try and unearth the end users' need for, and satisfaction with, economics input.

Getting early involvement in the matters at hand is critical. There are few episodes more dispiriting, and inefficient, than an investigating team getting a long way down the track, only to have an economist helicoptered in, late in the piece, with an alternative theory of the case that might necessitate junking much of the work to date. It's not always the economist that's the problem: legal counsel can come late to projects as well and be equally disruptive. Either way, an integrated multi-disciplinary team day one is a better way to go.

It's also professionally better for the economists themselves: most want to make a contribution and help come to a decision, and don't want to be sidelined waiting for the phone to ring. Graeme Woodbridge said that one quality he especially looks for is the ability to get off the fence and make the call, and if you're going to be effective in a competition authority (or anywhere else), you should have that roll-up-your-sleeves-and-give-your-best-take mindset .

One thing that became apparent was that, when you look at the work the economists actually do, econometrics is on the outer, for a variety of reasons, including the uphill struggle to get results through the legal process that have margins of error around them (as I described here). There is some quantitative analysis going on - I gathered from Simon Bishop's presentation that the EC is still doing (and may be overfond of) merger modelling - but it's deterministic. The assumptions you make drive the results that come out. Stochastic analysis of real world data doesn't happen, or happen much.

I may have got a bit obstreperous at this point. It dawned on me that, these days, economically literate governments wouldn't dream of taking big economic policy decisions without some numerate analysis of the likely effects. Could you imagine, for example, a government deciding to whack up the minimum wage, or bring in an emissions trading scheme, or do pretty much anything of economic significance, without taking account of the empirical work on its potential effects? Well, yes, I know you can, if you're thinking about dumb-ass governments, but in most civilised places we're all into evidence-based policies, as we should be.

So why do competition authorities think it's okay to let mergers of national importance go through without proper quantitative evaluation? And I had what might be a Big Idea: if you're challenging a competition authority's decision, why wouldn't you argue that there's an onus on the authority to do the hard yards on the econometrics? It's settled case law in New Zealand that the Commerce Commission should quantify where it can: should it be able to get away with defining a market, for example, without having a go at empirical estimation of elasticities? Especially as in this brave new world of big data, there's much more opportunity to get at the data you need (as I've argued before).

So I put this to the panel, and may have been slightly over the top in arguing that these days it's well nigh indefensible for a competition agency to do purely qualitative analysis. Got me nowhere: Graeme Woodbridge made the reasonable point that sometimes the data isn't there, and if it is, it's susceptible to different interpretations, and that's fair enough. But econometrics has advanced a lot these last few years, and it's a good deal better at teasing out relationships than it used to be. If the data isn't there, that's one thing, but if it is, I strongly suspect that, properly interrogated, it can tell us important stuff. And competition agencies shouldn't be making important decisions without seeing what it says.

While I was at it, I thought I'd ask the panel something else: if they had the luxury of researching economic issues that might be important in years to come, even if they're not immediately relevant to cases in the works, what would they bone up on? I didn't get a terrific series of answers, but Lilla Csorgo suggested creeping acquisitions, and assessment of the potential (typically post-merger) for tacit coordinated behaviour, where (if I've read my handwriting right) Lilla said the current state of economic thinking is "very poor".

Panel sessions are tricky things that can fizz or flop: this one worked, so well done to RBB's George Siolis who came up with a good set of discussion questions.

Roll up, roll up

At last year's NZ Association of Economics annual conference, I found a flier publicising Victoria's Master of Professional Economics programme.  And it gave me a bright idea.

I'd been thinking for a while about that awkward Catch 22 situation many economics - and other - graduates often face, where they can't get their first job without some experience and they can't get the experience without that first job. It applies all over the place across all sorts of areas - competition, regulation, banking, consultancy, investment management.

So I thought there could be a useful course which would give students both the traditional academic rigour and some practical hands-on exposure to one of the staples of many working economists' lives - figuring out where we are in the business cycle, and making enlightened stabs at where the cycle is headed next. And I got in touch with Dr Adrian Slack who is the director of Victoria's graduate programme in professional economics to see if Victoria would be interested in running with the idea. We talked it through and put together an idea of what it would look like.

The upshot, I'm pleased to say, is that Adrian has piloted the proposal through the approval system and it's up and running. MMPE523, 'Business Cycle Analysis and Implications' is good to go: as noted here, Prof Viv Hall and I will be taking it over the fences for the first time this coming summer trimester (November '16 - February '17). It'll cover the economic theory of cycles up to the present-day state of post-GFC reassessment, the history and causes of cycles in New Zealand - an area where Viv, with the Reserve Bank's John McDermott, is the pre-eminent cycle-dating guru - through to the practicalities of assembling the "where are we now" data, forming a coherent analytical view of what's going on, and building your own two-year-forward set of GDP forecasts. We're also planning on getting in some third parties (public and private sector) who can talk about their experience in building and using cyclical models and forecasts.

So the next time that dreaded job interview question comes round, and the student is facing, "So, tell me, have you done much forecasting?", the answer will be, "Well, yes, I've been quite pleased with how my GDP forecasting model has been going. And it's got something you might be especially interested in - as part of the exercise I've built this little model of...".

If this would suit anyone you know, spread the word. Adrian's the go-to man for more info.

There's always one...

Earlier this week the Commerce Commission came out with the second of its reviews of the sorts of contracts you and I get asked to sign when we sign up for our utilities. The latest one is a review of the electricity retailers (media release, full report as pdf); in February the Commission had gone over the typical telco contracts (media release, full report as pdf).

The Fair Trading Act, and the new bits in it on unfair contract terms which triggered these reviews, aren't usually my thing: to be honest, I knew nothing about the new provisions before the Commission's Ben Hamlin took us through them at last weekend's CLPINZ workshop. But now that I've looked at these reviews, I was struck by an unusual pattern which emerged from the pair of them. Here is the distribution of the number of potentially unfair contract terms found in each sector, by company.

Which is why I've called this post, "There's always one...". Because there is: in both sectors there is one company that's gone way beyond the others when packing its contracts with consumer-unfriendly terms. Equally there's one at the other end of the scale (in electricity it's more like a closely-bunched group of three) with remarkably few of the small print gotchas.

A good slab of these contract terms were not objectively necessary - as the Commission said on both occasions, "In some instances the companies were able to provide information to the Commission to show that the term was necessary to protect the legitimate business interests of the company. In all other cases, the companies accepted the Commission view and have amended or agreed to amend the terms concerned" - so it looks as if these patterns are telling us more about companies' culture than anything else.

At the greener end, while it's possible that some companies haven't thought hard enough about all the things that might go wrong, it's plausible that we've got companies that are more consumer-focussed, perhaps out of conviction, perhaps because they reckon that consumers may be relatively flighty and will leave if pushed too hard. At the redder end, we've got - well, I'm not sure. It could be just hard-nosed business, shifting as much risk as possible onto someone else, possibly on a view that most customers are relatively sticky. It could be that the company is being run by the lawyers. Or it could be that a company views consumers as "them versus us".

So it'll be an interesting market experiment to see which approach works best over the next few years. If I was currently down the redder end, I think I'd be minded to change course: competition is a multi-dimensional beast, and in competitive markets I don't think I'd like to get into the fray lagging badly on non-price dimensions like contract fairness.

As an aside, if you'd like a fascinating example of corporate culture losing sight of the customer, try this excellent article from Bloomberg earlier this year, 'United's quest to be less awful'. I especially liked this anecdote:

On Nov. 19 the airline announced it was changing the coffee it serves on its planes and in its lounges from a brand called Fresh Brew to the Italian premium roaster Illy. It was welcome news to customers and to the flight crews used to fielding complaints. It was also a tacit admission that the choice of coffee after the merger, a decision that consumed thousands of man-hours, took nearly a year, and involved everyone from [then CEO] Smisek to the airline’s head chef to the flight attendants, hadn’t worked out.

Poorer management, lower productivity. Makes sense

On Tuesday we had the Productivity Commission's excellent symposium on innovation  and productivity, where one of the main talking points was the growing importance of investment in 'intangibles' like research and knowhow. We're not especially good at it, as the three right hand bars in the graph below show (taken from this recent Productivity Commission working paper, 'Measuring the innovative activity of New Zealand firms' - symposium attendees will recognise it from the brochure).

By coincidence the Peterson Institute for International Economics in Washington had a conference last month on 'Making Sense of the Productivity Slowdown' which covered some of the same landscape. One of the presentations in particular was quite suggestive about one of the intangible knowhows we could do with a bit more of - and that's managerial skill.

The LSE's John Van Reenen was talking about 'Productivity Issues: Past, Present & Future'. He's been working with a sophisticated index of management expertise: you can find out more about it at the World Management Survey website, but in essence it grades companies, on a 1 to 5 scale, on how well they do 18 different management things. Van Reenen (and others) have then gone on and looked at the links between management expertise, as measured, and various financial and economic outcomes. They are generally sizeable: here, for example, is the global link between a firm's Total Factor Productivity (TFP) and the quality of its management.

TFP, by the way, for folks not versed in the black arts, is the bit of a firm's performance left over after you've accounted for the contributions of its workforce, its employees' skills, and its capital spending. At one level it means "anything we can't get a handle on", but it's also often used as a shorthand for important intangibles like management quality, social skills and "the way we do things round here", and smart processes.

In this latest outing, he's had a go at explaining differences in countries' TFP: if you make a plausible assumption about management's importance in overall TFP, and you have measures of TFP and management expertise, you can estimate how much of countries' TFP differences is down to differences in management. Often, in these kinds of surveys, New Zealand tends to be among those absent, but for once we're in the numbers, and here are the results. Differences in TFP are measured as a percentage of the US level. I've circled NZ in red.

Now, I think we can all agree that this is somewhere down the more heroic end of estimation, and also that there are the usual issues of correlation and causation. But we can also agree that rough and ready estimates, that are approximately in the right sort of area, are also useful things to have. 

And I think there is something to this one. The overall pattern looks realistic: poorer countries at lower levels of development - the ones on the left with, say, less than 20% of America's TFP - tend to have bigger issues to confront than the relative quality of their management, and sure enough the contribution of management to the development gap tends to be low. But at higher levels of development, where you've got higher levels of resources available, how you manage them becomes more important. 

On these estimates, 43.5% of the productivity gap between us and the States is down to our relatively weak management capabilities (and it's interesting that Australia, with a somewhat similar business environment to ours, comes out with a similar number, at 45%).  These numbers also sit comfortably with other evidence that our management capabilities aren't that flash: for example, the Productivity Commission's services inquiry found some data that suggested that low ICT uptake appeared to be linked with a "couldn't be arsed" approach by business owners (as I posted at the time).

Even if the proportion is uncertain - let's just say it might be somewhere between a quarter and a half - it makes for a significant line of attack if we're thinking about better management's potential contribution to narrowing the productivity gap with overseas. There were some neat ideas at this week's productivity symposium - but they're not going to get the traction they should if our business managers are slower to run with them, or worse at execution, than their overseas competitors.

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.

Lies, damned lies, and durables orders

There are days when you really, really wonder about the efficiency of the financial markets.

Apparently (according to the AP coverage), US shares have been sold off because "Traders were discouraged to see that orders for long-lasting manufactured goods fell in February for the third time in four months". The weak state of US durables orders appears to be having effects closer to home too, with the Sydney Morning Herald saying yesterday that "The [ASX] market was down from the opening bell as Wall Street stocks were sold off sharply after unexpectedly weak US durable goods orders".

Could everyone get a grip, please?

Here are the durables data they're all supposedly worried about (from the terrific, and free, FRED data resource that the St Louis Fed provides).

Over longer timeframes, the monthly changes in the durables orders series are pretty much useless as a cyclical guide. You did get a run of consecutive falls in the post-GFC recession (the darker shaded area in the graph), but that's it. Even in what is now a prolonged recovery, you don't get a corresponding clear string of good durables numbers: if there is one in there somewhere, it's been well hidden by the monthly volatility.

It's even worse if you're not taking the longer view. Here's the past couple of years on their own.

The volatility is very large: 4% or 5% moves up or down in a single month are quite common, with the occasional even larger humdinger to throw you completely like that 22.6% spike in July '14 (some huge order for transport equipment, as it transpired).

So the noise is immense, and the signal (if there is one) is inaudible. I know journalists have to write something to keep the ads apart, and economists and analysts have to do something in the office till the pubs open, but durable goods orders? Really?

Playing monopoly

Monopoly is in the air. The kiwi fruit people want more of it: the Herald's coverage of their recent industry poll is here - where I learned that the polite word for "monopoly" these days in kiwifruit circles is "single point of entry" - and the meat industry would like some, too.

That's one of the core recommendations in a recent report by Meat Industry Excellence (and I should tip a hat in the direction of John Small's website, where I first saw mention of it). They're a ginger group who describe themselves as "passionate farmers and industry supporters who can clearly see the opportunities (and the barriers to progress) for our red meat sector. They are a diverse group who are prepared to stand up, collaborate and work with farmers and industry to create sustainable profitability for all players".

Fair enough, and actually I have some sympathy for their diagnosis of what ails the meat industry and for their vision of creating and capturing high value add through a focus on the end consumer (though if you can also hear the hoofbeats of a "But" galloping towards us, you're right). Stock numbers have dropped sharply, stranding processing assets, which means that a deadly game of musical chairs is underway. Processors are playing over the odds to get stock through their plant rather than the other fellow's, adding to the financial costs of carrying the surplus capacity, and leaving nothing over to pay for the marketing and innovation that would raise industry incomes all along the value chain (there's an argument that that the processors were never that good at the marketing end even in better times, but that's for another day).

Their suggested ways forward are some combination of industry aggregation (to something like a Fonterra-sized processor), a collective approach to rationalisation of the spare capacity including a cunning plan, 'chain licensing', which would cap capacity, and a collective or coordinated approach to export marketing, perhaps along Zespri lines. That's my potted summary: Rod Oram's got one here, and Lincoln's Agribusiness and Economics Research Unit have a rather longer one here.

What bothers me about this is the strong lean towards monopoly market solutions at the expense of competitive market solutions. It's not universal:  the draft paper on the chain licensing says, for example, that

Competition and choice at the farm gate must remain. Animosity by some processors against competition is misplaced.

Competition is essential for the Industry. It is overcapacity and lower livestock numbers which has led to the low plant utilization within the Industry...Marginal pricing, refusal to close plants because of high redundancy costs, focus on throughput and fixed cost amortization, excessive use of third party buying agents, and adding extra capacity are all competitive responses that are rational within the current structure of so much additional capacity. They result not from the principle of competition but from overcapacity

But otherwise it's pretty much pervasive among those casting around for potential ways forward to reach for Fonterra and/or Zespri as proven models from other industries. Fortunately, some of these ideas are non-starters. Animosities and incompatibilities among the processors likely put the kibosh on all the grander schemes of agglomeration, as would the Commerce Commission, since I don't see the required authorisation as likely to be forthcoming: orchestrated stitch-ups to create monopsony power against suppliers and monopoly power against consumers rarely get the nod, and for good reason. And the chain licensing idea would also need some get of jail free card, as it too looks bang to rights under the Commerce Act. But even if they were enabled through the meat industry equivalent of the legislation that created Fonterra, they look to me to be the wrong approach, for two reasons.

One is that there are, in fact, good working examples of thriving, competition-based, agricultural export industries, with the outstanding example being our own wine industry (and arguably another in the making, in the craft beer trade). And the French wine and cheese trades successfully get their Cotes du Rhone and Roquefort to me using exactly that model of large numbers of French companies competing against each other for the same overseas customers that is supposedly the "problem" that the Zespri route is meant to "solve". So it's by no means a given that Fonterra-style or Zespri-style models beat market models, where competing companies are forced to add value and to innovate to succeed. And  it is worth remembering that the Commerce Commission, when the original Fonterra idea came through their door in 1999 before the thing got its own legislation, found that "the Commission has reached the preliminary view that it cannot be satisfied that the public benefits of the proposed merger are likely to outweigh the competitive detriments".

And the other is that chain of links that goes: create a monopoly, generate more profit, use the money to fund product and market development. You can certainly do the first two, but the third leg looks highly suspect. A monopoly is just about the last organisational form you would expect to be highly consumer-focussed and highly innovative. We've got the magnificent diversity of our premium wine offerings, very largely driven by micro, small and medium-sized companies, all jostling with their ideas in the marketplace: does anyone seriously believe a Wine Export Board would have achieved a tenth of that success?

Smoking gun found as drug deals go down

I've been a bit exercised by these "pay for delay" drug deals where patent holders buy off generic drug competition - see here and here - and I know I'll have to let them go, and get on with other things, but one final post on the topic, as I've been pointed towards a brand new piece of empirical research on them that finds that they are very likely anticompetitive.

Up front, I should say that I'm normally minded, when I see some business behaviour that doesn't look like it fits with what the economics theory would suggest a firm would do, to look for a benign, rational explanation. Businesses will often have logical and proper reasons for what they do, even if on first inspection an economist can't see what those reasons are. And I've even changed my mind on some things that I would once have regarded as out of hand anticompetitive (retail price maintenance, for example) and I can now see why a company might have a legitimate reason to do it, and why consumers might not be harmed or could even benefit.

But at first blush these "pay for delay" delays looked suss to me, and although there are respectable and even heavyweight competition economists (Willig, for example) who believe they are, or can be, above board, I'm at a minimum still of the view that most "pay for delay" deals are rorts on the consumer.

So I was intrigued when a blogging colleague put me on the trail of "Do "Reverse Payment" Settlements of Brand-Generic Patent Disputes in the Pharmaceutical Industry Constitute an Anticompetitive Pay for Delay?", by Keith M. Drake, Martha A. Starr, and Thomas McGuire, NBER Working Paper No. 20292,July 2014, © 2014 by Keith M. Drake, Martha A. Starr, and Thomas McGuire (the copyright thingy is there because the NBER papers say third parties citing them have to put it in).

You can see the abstract here and you can read the whole thing if your organisation has a sub to the NBER or if you fork out US$5 online. If you're in the teaching trades, and in particular if you're in the competition teaching trades, you might want to share it with your students, as the topic is interesting, the writing's accessible, and the maths and stats are fairly easy.

The researchers looked at settlements of patent drug litigation between incumbent patentholder companies and generic competitors, and split them into two buckets - those where there were "reverse payments" from the patentholder to the generic, and those where there weren't. "If, in settlement, the brand manufacturer in effect buys a longer period of monopoly sale by “paying for delay” with a “reverse payment,” expected profits to the brand go up", they reasoned (p12) - "longer" here being longer than the average outcome that would have been expected from fighting on in the litigation. So they looked for the stock price impact of news of settlements, which should quickly reflect that rise in expected profits by way of higher share prices. And, since it's at least possible that settlements might have been struck for good reasons that weren't anticompetitive, they were especially interested in whether the settlements with reverse payments had a bigger effect on stock prices than the ones that didn't.

They were pretty careful, too, to isolate the impact of the news of the settlement, by comparing the actual share price movement with three different measures of what might have happened to the share price in the absence of the settlement. So they looked for "abnormal" or "excess" returns over and above what the company or the share market might have delivered in any case.

This is their key result (pp26-7): "For multiday event windows" - that's where the share price impact is measured over a few days - "cumulative abnormal returns for the reverse payment settlements are 5.5% to 6.0% higher than those for the other settlements and in all cases the difference is significantly different from zero...the incremental stock price jump of approximately 6% upon announcement of a settlement with indication of a reverse payment compared to one without is consistent with the hypothesis that reverse payments buy an anticompetitive delay in generic entry".

Incidentally, they also looked at trading volumes (again compared with the volume that might have been expected in any event), and again the same pattern came through. Investors were much more interested in news that the money had changed hands than in news that it hadn't.

Maybe I'll have my mind changed by some new evidence, but on this showing, if there are strong incentives to wreak a rort (check), and it looks like a rort (check), and it's carrying a large sack of non-consecutively-numbered dollar bills under one arm (check), it's a rort.

How productive are we?

Yesterday Stats came out with the latest productivity statistics. They're very important numbers: in the long run, it's productivity that largely determines our standard of living, and if you've ever engaged, or want to engage, with why incomes here seem to have slipped compared to the OECD as a whole, or compared to Australia, then you need to start out armed with the basic info on what's actually been happening here.

Here are some of the key findings, taken from the full Stats release. And if you'd like someone else's coverage as well, Patrick Smellie at the NBR did a piece (outside the paywall) which quotes the ANZ's chief economist Cameron Bagrie.

Here's a table of the overall picture.

Two explanatory comments. You'll see that these are numbers for "the measured sector", which is where it is easier for Stats to measure productivity. The missing bits are central government, education, and health, where measuring productivity is iffier (though not impossible), but even so the "measured sector" covers quite a big slab of the economy (about 80%).

And those time periods, which look a bit arbitrary at first, are based on the idea that you ideally need to measure productivity from one point in one business cycle to the same point in the next business cycle. Productivity numbers can get badly thrown off if, for example, you went to measure from peak of boom to bottom of bust (or vice versa). The latest cycle (2008-13), incidentally, is still underway, so we're far from the last word on what's happened this time round.

So, what's been happening?

First, output growth per annum (0.8%) in this latest cycle is low, but that's because we've got the GFC in there (output -3.0% in the year to March '09, -0.4% in the year to March '10), and anyway it's accelerating since. The year to March '13 was good, the year to March '14 will have been better, and it's highly likely that the year to March '15 will be even stronger again.

Second, the GFC and its aftermath were not kind to employment and hours worked, so the quantum of labour input has actually fallen over the period (largely due to a contraction by -2.4% in the year to March '10). This will obviously change as we add on more recent data.

Third, growing output (however slowly) but falling labour input means that labour productivity went up. Obviously we'd all prefer if we got higher labour productivity by labour input going up quite a bit and output growth growing even faster, but there we are. These were difficult times, and the good news is that labour productivity increased by 1.5% a year, about the same as our longer-term average (1.6% a year over 1996-2013). Not a bad outcome on the back of one of the most difficult business cycles in living memory.

If you rearrange a formula a bit, you can get an insight into where this increased labour productivity came from. It can come from each person working with more capital equipment ("capital deepening"), or from something else ("multifactor productivity", MFP, which is shorthand for everything that isn't more labour input or more capital input, and includes everything from technological and process innovation to better management and learning by doing). Here's the outcome.

You'll see that this time round (or at least up to March '13) people have been able to produce more largely because they have had more gear and equipment to work with. The good news is that the capital spend has kept up. The bad news is that usually we get more of a productivity kicker from all that "everything else" MFP stuff, and that hasn't kicked in to date in this cycle. But as you can see, 2013 showed more of a MFP boost, and hopefully we'll see more again this year and next.

We don't need to spend all our time comparing ourselves with the Aussies, but it's an interesting exercise all the same. Here are the numbers.

You'd be tempted to conclude that the reason for the gaps in output growth and labour productivity growth, in Australia's favour, are all down to the benefit that the Australian workforce gets from bigger increases in the capital equipment they've got to work with.

That's actually a bit of a statistical illusion. It's true that the capital deepening component of the gap between our output and productivity performance is growing, yes. But it's still a smaller component than the MFP contribution. Geoff Mason of the UK's NIESR has done the comparative exercise in detail (I covered it here, a short form of his results is here and the whole thing is here), and broadly speaking 60% of the productivity difference is down to better and more inventive ways of organising their affairs in Australia (MFP) and 40% is down to the Aussies having more gear to deploy (there's also a small difference in aggregate skill levels, which I've ignored).

A lot of this will be of greatest interest to hard core macroeconomics types, but I think there's also an important lesson for management everywhere lurking in these numbers, and it's this.

On average, the measured sector has been able to generate MFP growth of 0.7% a year over 1996-2013: in other words, without hiring a single extra employee or installing a single extra machine, organisations have been able to produce 0.7% more each year with the same resources. I'd like to see that number being used. It ought to be built into people's performance targets and business units' business plans - and public service budgets, if it comes to that.

The economics of Game of Thrones

I'm a reader, the old-fashioned kind. The house is full of books, there's a stack of unread ones beside the bed and a Unity Books loyalty card in my wallet, I've got accounts with Amazon, and Barnes and Noble, and The Book Depository (NB no postage charges to New Zealand). I've got nine library books currently checked out, and another five books stacked up as requests on the (excellent) Auckland Library system.

And normally I wouldn't give you tuppence for the film or TV adaptation of any book I've read, as I like to think the images you create for yourself when you read are better than the ones confected for you by someone else. Especially when the confections are by the big US studios, where you're pretty much guaranteed a dumbed down slab of sugary pap.

With one big exception.

I passed on the books. And I let three and a bit seasons of the TV series go by before deciding to give it a try. And then I got hooked on - well, you saw it in the title of this post, it's Game of Thrones. I binged on the thing, two or three episodes a night till I'd done the lot.

Why, you ask, is this in an economics blog?

First up, because I was kind of intrigued by the reaction of the makers of Game of Thrones (HBO) to the news that GoT was the most pirated TV show of 2013 (ditto in 2012). Instead of the "piracy is killing Hollywood" moaning you might have expected, they were upbeat about it. In this article, for example, we got the views of the top brass:

Similar to Game of Thrones director David Petrarca, [Jeff] Bewkes [CEO of HBO's parent company, Time Warner] believes that the free word of mouth advertising eventually leads to more paying subscribers.

“Our experience is that it leads to more paying subs. I think you’re right that Game of Thrones is the most pirated show in the world. That’s better than an Emmy,” Bewkes said.

I'm aware, from expert economic evidence given in legal proceedings, that there are theoretical arguments that piracy may not in fact harm the copyright holder, though I have to say it's always looked a bit of an uphill argument when stacked against what looks like a more immediately obvious "taking the bread from our mouths" line. I suspect that economists in the expert witness game who take a benign view of piracy will be making good use of this latest GoT evidence. And I also suspect that we are in the absolute infancy of internet business strategy: when the makers of a red-hot series are relaxed about piracy, you sense that they are on to something that isn't yet in the Harvard Business Review.

And second, what's all this about piracy?

Did I go trolling through the deepest darkest internet for GoT? Visit dubious torrent sites? Set up some devious VPN workaround to convince US sites I wasn't in New Zealand?

No. I went to Polly Streaming. I've no idea who they are, and their 'About us' page is uninformative, but they offer basic free services (which include the whole of GoT) plus a premium subscription, and have a Facebook page, so they're hardly lurking in some shadowy internet lair. And they don't seem to care where in the world you are. All of which tends to suggest that the GoT folks know all about them, and either don't give a damn, or reckon it's a good thing, or are actively in on it with them. Every which way, you sense, again, that there's a cunning strategic plan behind this "piracy".

And then there are the economic lessons from GoT itself.

The big lesson from GoT is that if you're spending up big, spend the money on the right things. If the choice is (and it often seems to be), (A) spend US$20 million on the bankable name that you think will put bums on seats no matter what the movie is, or (B) spend US$20 million on sets, locations, effects, no-name but highly competent actors and a quality product, then HBO has successfully demonstrated that the second choice works better, no matter what the bean counters might advise. The more I look at successful products, the more I'm convinced that out of the SPQR mix (service, price, quality, range), quality trumps all in the longer run.

Another lesson is that the public is not made up of ninnies in a convent school. Do we want to watch only MLVS movies? No. But do we want to see sanitised, infantilised, prettified versions of MLVS issues? No we don't. GoT treats its customer base like adults. And like most business strategies that rely on people being intelligent judges of the product, it's a winner.

Another is that it made me wonder about the supposed wonderfulness of our new Ultra Fast Broadband (UFB) rollout. My copper-based ADSL internet service delivered GoT to my laptop, with completely acceptable video quality (and I'm not even getting the top end of copper-based delivery). Remind me why I need to pay more for the same experience delivered over fibre?

Finally, I was struck by the quality of the GoT opening credits. And it seemed to me that there was a good economic motivation for the high quality (as there was for the equally stunning opening credits for the Rome series). Bankers used to adopt the same strategy, and for the same reason. How do you signal to new customers of an intangible service, who know nothing of you or your reputation, that you are a quality service provider? In the case of banks, and I'm thinking here of the likes of Irving Trust and Morgan Guaranty and their erstwhile palazzi on Wall Street, by having extraordinarily opulent-looking head offices. Look how rich we are! How dependable!

And so it goes with the opening titles. Put your production values into the opening - sophisticated computer graphics, lush colouring, an original and striking theme tune, a bit of ambiguity, a hint of special effects - and before they see the rest of it, consumers are convinced that here's a quality product that's had thought and money spent on it.

Maybe, to come full circle, you can't judge a book by its cover. But you can choose a TV series by its opening.

Follow the money...

I know I've said it before, but there really are so many business surveys around these days that even dedicated economy-watchers can't keep track of all of them. Inevitably some slip under the radar.

One you might have missed (and I came across it only accidentally while foraging a while ago for something else on the bank's website), is the quarterly ASB Kiwi Dollar Barometer. It's well worth having a look at: it's quite a decent sized survey (390 firms with turnover of at least $1 million) of businesses' exchange rate expectations and their forex hedging plans.

The latest one came out last week. The headline result was that businesses (averaging out both importers’ and exporters’ views) expect the Kiwi dollar to peak against the US$ around the 81 cent mark  in the March ’14 quarter, and to decline to 76.5 cents by the end of next year. Currency forecasting, many would say, is a complete waste of time, and perhaps these businesses' expectations will prove just as wide of the mark as any other forecaster's. But I doubt it.

For one thing, consensus forecasts across wide groups tend to do better than a single guy with his spreadsheet.

And for another - and this, to me, was the really interesting bit - the businesses are putting their money where their mouths are, as this graph shows.

Notice that the percentage of importers planning to hedge has hit a new high: in real time, with real dollars, import businesses are increasingly taking out protection against the Kiwi dollar falling.

You might wonder (as the ASB economists did) why the proportion of exporters planning to hedge also ticked up a bit in this latest survey - if they really believed the Kiwi dollar is going to fall, they'd be planning to do less hedging. The ASB team commented that "It is likely the recent strength in the NZD has seen exporters look to protect themselves against further increases in the NZD, even if their core view is that the currency will ease over the year ahead".

I think this is absolutely right, because I've seen this happen before. Years ago I worked for a forex consultancy business in London, and our customer list looked like a hospital ward: every corporate in Europe that had run into financial grief appeared to be on our books as clients. Why? Because they were already in such a difficult position that the last thing they wanted was to have forex losses on top of everything else.

And that's where Kiwi exporters are right now. They might believe the Kiwi dollar is going to fall - but they can't live with the risk that it might tighten the screws even further on them with another bout of appreciation.

I'll drink to that

Last weekend I was browsing Jancis Robinson's wine column at the Financial Times, and discovered two interesting things I hadn't known from her latest article, 'Value judgments: my favourite wines selling for under £10'. Incidentally if you like her column, or the FT's mainline financial and economic coverage,  it's well worth either registering for free with the FT to get a monthly quota of articles, or subscribing, to get the whole online shebang, which is what I've done.

The first thing I didn't know was that New Zealand hosts what Robinson calls "the leading wine-price comparison site", high praise from a world wine authority. It's called Wine-searcher, and it is indeed very good. I can already feel a couple of cases of Côtes du Rhone coming on.

The second thing I discovered, and this is where we veer back into the world of economics, was that Wine-searcher has apparently done a seriously large-scale study of price dispersion on the internet (250,000 US wine prices, 74,000 UK wine prices). I couldn't find the study itself on Wine-searcher's site, so I'm reliant on Robinson's summary of it, which was: "Wine-searcher’s analysis found that it was not uncommon in 2003 for US retailers to charge up to 50 per cent or even 100 per cent more than the middle price; now, thanks to greater transparency, this is virtually unheard of. According to Wine-searcher: “In the past it was relatively common for merchants to charge 25 per cent more than their competitors. Currently only 6.5 per cent of merchants in the US and 6.2 per cent in the UK try to charge 25 per cent or more over the median price whereas historically these percentages were 27.1 per cent and 12.7 per cent respectively".

Robinson comments that "there is less gouging today than there used to be", and I'm sure she's right. In theory, suppliers charging more like each other doesn't necessarily mean that the market's become more competitive: near-identical prices are as consistent with near-perfect collusion as they are with near-perfect competition. But it's rather unlikely that there has been global collusion amongst multiple retailers across many, many different wine prices, and much more likely that consumers are getting a better deal as increased transparency has reduced the capacity of sellers to quote exorbitantly out-of-line prices.

This was one of the things that was supposed to happen as the internet became more popular, but it's taken a while to arrive. When I went to the AEA meeting in Washington in January 2003, there was a session on price dispersion and price convergence over the internet, and (as I remember it) the gist was that, at that stage, online prices were, somewhat surprisingly, just as disperse as the bricks and mortar ones. This is consistent with Wine-searcher's finding that there was still widespread price dispersion at that time.

I've been trying to find studies of pricing of other goods and services over the internet, to see if the same pattern of reduced price dispersion and better deals for consumers holds true outside the world of wine. So far, it's been an uphill struggle. If anyone can point me to good research in this area, I'd appreciate hearing from you.

Competition to the rescue - again

The Reserve Bank issued its latest quarterly Bulletin today, and it included a chapter on why inflation has turned out lower - much lower - than the Bank (and others) had expected. Here's the guts of it, in one graph.

In this graph, the Bank's decomposed why its June '12 forecast for inflation in June '13 (2.1%) turned out to be so much higher than the actual outcome (0.7%). The biggest single contributor was the unexpectedly high level of the Kiwi dollar, but there were actually contributions from all over the place, with both tradables and non-tradables prices lower than expected.

It's nice to see that greater competition placed its part in this. The Bank mentioned in particular the impact of lower communication prices (something I've posted about before) from a mixture of increased competition (the likes of 2degrees arriving) and price-reducing regulation (of costs such as mobile termination). Here's the impact - a cumulative drop of more than 15% in price over the three years to June '13.

But competition has also been hotting up in the rest of the economy, as this very interesting graph shows.

To measure the increased degree of competition, the Bank has cleverly dug out the percentage of goods on 'special' (a statistic that Statistics NZ collects as part of its data gathering for compiling the CPI). And it's found that the percentage of goods on special has been rising steadily in a number of sectors. The Bank commented that "The unusual combination of relatively subdued domestic demand and a persistently high exchange rate has resulted in strong price competition, with greater-than-usual levels of price discounting (figure 11) [i.e. the graph you see above] and many retailers reporting pressure on profit margins. Persistent strength in the exchange rate results in imported input costs staying low for a prolonged period. As a result, retailers are likely to be more confident about passing reductions in wholesale costs though to selling prices".

To be honest, I wasn't aware that Stats published this data, and in fact, I gather from the ever helpful Chris Pike, Manager Prices at Stats, that it's not a regular part of the CPI release, but has been made available at recent press conferences when the CPI has been released.

Chris sent me through the data on price discounting since December '08, and very interesting reading it made, too. Currently 14% of everything in the shops is being called a 'special', with the percentages varying markedly from sector to sector. The big discounters are major household appliances (38% of prices on special); furniture and furnishings, and electrical appliances for personal care (both 35%); small household electrical appliances (32%); glassware, tableware and household utensils (28%); household textiles and audio-visual equipment (both 26%).

What's going on here is partly a marketing ploy, of course: what's being called a 'special' is in fact no more than an attractive way of packaging lower import costs. But irrespective of what it's called, the good news is that more and more retailers are having to pass through those lower import costs to us consumers. It may not last, if that "relatively subdued domestic demand" picks up and retailers figure they don't have to scrap as hard as they do now, but enjoy it while it's all on. And tuck away the longer-term lesson from this, which is that competitive markets are your first-best protection against rorts and profiteering. 

Speaking of which, I couldn't help noticing the sectors where discounting isn't taking place, even though you would guess that the exchange rate has been benefiting those import-heavy sectors as much as it has been benefiting the likes of TVs. 

It didn't surprise me in the least that pharmaceuticals had only 6% discounted, nor that "other medical products" only had 1% discounted. Bastions of competition, these are not. More surprising were new cars (6%) and new motorbikes (3%). Maybe lower import costs are being passed on to consumers in some other way, maybe as lower base sticker prices, rather than as 'specials' off hypothetical list prices. 

I certainly hope so, because on the face of it those numbers look well off the pace. If the Commerce Commission ever gets the powers to proactively investigate the state of competition in particular markets (something I have been lobbying the Productivity Commission to recommend), it could do worse as a starting point to look at those markets where retailers don't seem to be as sharp-pencilled as the others.