How's the other property market doing?

The latest global commercial property survey from the Royal Institution of Chartered Surveyors in the UK came out recently, and it said some interesting things about our commercial property market - the market that gets trampled in the reef fish rush to cover the residential property market. You can download the latest, March, report for yourself from the RICS site (head for the 'Knowledge' section), though there's a (free) registration process to get at it.

Here's the most dramatic result.

When you combine the demand from tenants with the demand from investors, we have the strongest commercial property market in the world right now. It's become fashionable to mock our 'rock star' status, and it's true we're probably past the peak growth rate of the current business cycle, but every now and then it's worth noting that by international standards we're still doing pretty well. For example - and I'm not knocking Australia, we need its economy to be a strong export market for us - you can clearly see what the current sub-par rate of growth in Oz has been doing to tenant demand there.

Another reaction might be that we're doing rather too well for financial stability comfort, especially as overexuberant commercial property markets tend to be near the front of the queue in financial crises. Here's another RICS chart.

It doesn't look to me that rent and capital gains expectations in our property market have got out of hand. They're fairly strong, but we're in the middle of the better performing pack, rather than at an extreme. That said, as the RICS commentary noted, "more respondents in the majority of markets now believe that commercial property in their locality can be categorised as either expensive or very expensive rather than cheap", a consequence of the global hunt for residual pockets of yield in a world of ultra-low interest rates on bank deposits and bonds.

An alternative way of getting to the same conclusion, that our commercial property market is on the expensive side but not at silly levels, is to compare the dividend yield on our listed property securities to those overseas. The yield on the FTSE EPRA/NAREIT Global Real Estate Index (which you can find here) is currently 3.27%: our yields haven't fallen so low. A representative selection: Kiwi Property 5.25%, Precinct Properties 5.92%, Property For Industry 5.77%.

I really like these RICS reports (I know, I've said it before). We don't have a lot of other info on what can be one of the more important moving parts in the cycle: they fill a real gap:

Unfinished work - and what it's costing us

There's been some discussion on Twitter and elsewhere about whether enough has been done under the current or previous governments to achieve 'transformational' change - something big enough to make a real difference to New Zealand's potential rate of growth and future standard of living.

As it happens, the OECD  has got something useful to add to this debate, both on the issue of whether enough is being done, and on what the transformational changes might be. Its Going for Growth series has been coming out every other year since 2005, and is squarely aimed at identifying priority policies that would raise countries' rates of economic growth. You'd have thought that it would have received a ready hearing in New Zealand, where relatively slow growth over long periods of time is our number one economic issue, but strangely enough the amount of media attention it gets is generally minimal - this year's version also came and went (in February) with little local coverage.

One thing the latest version says (press release, summary etc here and the whole thing online here) is that appetite for transformational change has waned across the developed economies: it's not just us. After a burst of 'we've got to do something' fervour during and immediately after the GFC, "The pace of structural reform has been slowing in the majority of advanced countries across the OECD over the last two years" (p16). And that means that large, 'transformational' potential gains in GDP are being left on the table. As the OECD calculates it

The OECD's also done a country-by-country calculation of how much GDP would increase if its proposed reforms were put in place: here's the result (extracted from Figure 4.5 on p120) of the 'moderately ambitious' one (the OECD also had one scenario that was less ambitious and one that was more ambitious again). We'd actually gain more than the average OECD country if we got on with it.

What sort of reforms does the OECD have in mind we should carry out?

Before showing the full list, it's worth pointing out that the OECD puts its policies into two boxes - the 'labour utilisation' box holds the policies designed to get people into work (eg liberalising labour market regulation), and the 'labour productivity' box holds the ones designed to boost how much people can do when they are employed. In our case, the focus is almost completely on the 'labour productivity' box, as this graph (extracted from Figure 1.5 on p29) shows. It explains how much of each country's income level, relative to the average level of income in the top half of the OECD, is down to labour use and how much down to to labour productivity. In our case, it's entirely down to labour productivity: we're actually better than many other countries at getting people into work, but we lag when it comes to what they produce when they're employed.

So here's the full set of proposed policies.

It's a balanced list. Yes, there are things there that won't appeal to the lefter-wing end of the world (such as privatisations). But equally there is a strong emphasis on fixing socially inequitable outcomes in education and health. Because of the mix, it's probably unlikely that any one government is going to be able to pick them all off: at best we might get one government doing one subset, and the next government doing the rest (and hopefully not unpicking the first lot).

Hopefully we can work our way through them one way or another: as long as they're left undone, we're some 8% poorer than we need be.

Overgenerous protection?

I'd never heard of the Express Scripts prescription-price index before I read 'Much ado about something', an article on generic drugs companies in the latest issue of the Economist (it may be available here but it may be paywalled, I can't easily tell as I've got a subscription). The article said that "whereas the average price for branded medications in America has risen by 127% over the past seven years, the average for generics is down by 63% over that period".

I was rather intrigued by this from a competition perspective, so I went to the source. Express Scripts is a US listed company that provides various pharmacy processing and management services, and it has a website, 'The Lab', where it publishes a range of interesting analysis and research. One of its publications is its Drug Trend Report, and on p57 you'll find this graph of the prescription-price index, which measures the prices of the most commonly prescribed drugs in both their branded and generic versions (it's also on p6 of the Executive Summary pdf).

It's hazardous drawing conclusions from one country, and one country with a rather dysfunctional health system at that, but these patterns do lead you to wonder whether patent protection hasn't been overdone. Yes, of course, the costs of developing safe new drugs are high and rising, and patents should enable drugmakers to recover their costs and earn an appropriately risk-adjusted rate of return on their outlays. And yes, you'd have to do the heavy lifting of comparing actual and fair WACCs to be make a fully informed call (and even then there'd be judgement calls involved). But price divergences of this order at a minimum make you wonder whether the length or scope of protection haven't been overdone. Overgenerous protection  would also help explain the squalid trade of branded producers bribing potential generic competitors not to produce (as I wrote about here, here and here).

I'm hesitant even to mention the Trans Pacific Partnership - every anti-trade nutter in the country will be reaching for their tin-foil helmet - and I'm going to reserve final judgement on the thing till I see all of it as a package. But if, as has been widely speculated, one of the elements is extended life for intellectual property protection, then it's probably a step in the wrong direction.

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.

The shape of our competitive landscape

Every now and then there's a debate about our industrial structure. Some argue that as a small economy we've already got an issue with industries that are too concentrated, and so need to be unusually alert to collusive oligopolistic behaviour, while others argue that we're nowhere near concentrated enough, and that our fragmented industries need to bulk up so we've got companies at the fighting weight to be internationally competitive.

There's a lot of interest in the issues. The viewing stats for this blog are currently showing that my most read piece at the moment is the post that criticised the 'national champions' approach, not that it's easy to kill it off. There have been a number of recent moves in that direction, as I reported here.

In any event, it occurred to me that I didn't have too clear an idea of the actual concentration of New Zealand markets and the strength of competition within them. And then I remembered that Stats' Business Operations Survey (assorted links to commentary and data here) has a question about how many competitors respondents thought they had. I've played around with the data, and here are the key results, by size of business.

Is this benign or troubling? On the plus side, the typical situation faced by a New Zealand business is one of many competitors, with a core of several bigger ones (the "several dominant" phraseology comes from the survey questionnaire, and is a bit at odds with how competition folk would normally use "dominant", but it's pretty clear what the responses must mean). Add in the 20% or so of firms who face multiple competitors, with no especially big ones in the mix, and you find that 70% or so of businesses operate in what are likely to be reasonably competitive markets (I know, numbers of firms don't automatically align with intensity of competition, but it still looks the way to bet).

On the troubling side, close to one fifth of all businesses say they operate in a duopoly or triopoly, and another 5% say they've got a completely captive market with no competitors at all (and, I'd guess, some of those in the 5% of "Don't knows" might be in the same boat, but would probably not prefer to say so).

So after a first pass through the data, there's no knockout evidence either way: there's evidence for a mostly competitive economy, and there's evidence of potentially problematic concentration. If you feel like having a closer look yourself, you'll find the underlying data at NZ.Stat, in Module A of the Business Operations Tables.

Incidentally, if you were minded to take the radical step of asking a competition authority to account for whether it's making any difference or not, you could do worse than put "the proportion of businesses reporting a captive market or no effective competition" onto its shopping list.

How do supermarkets compete?

In the previous post I wrote up the results of the Electricity Authority's latest survey of competition in various industries: supermarkets came out tops in terms of people's assessment of whether they are getting a competitive deal from businesses they deal with. While it wasn't a full economy-wide survey, and maybe there are unsurveyed sectors that would have shown up better than the supermarkets, it was nonetheless very interesting that people feel they are getting a fair deal from supermarkets vying for their custom, and all the more so because there have been concerns about a potential duopolistic shakedown.

As it happens, I just came across another new survey which tells us in more detail what people value from supermarkets (it's Australian, but I'd suggest it's equally applicable here). It comes from Roy Morgan Research's 'Single Source' surveys, which are very large scale: this supermarket one had close to 16,000 respondents, all interviewed face to face. The press release is here (the full thing costs serious $, which is fair enough given the scale and value of the exercise).

Here's the core result, where we can see the various dimensions across which supermarkets compete, and which ones most press consumers' buttons.

Before seeing these results, I'd have guessed that some dimension of all-in-one convenience would have topped the list, supermarkets being (you'd think) the classic economies of scope/minimise transactions cost model, but I'd have been wrong. There are, to be sure, some convenience dimensions in the most valued characteristics of a supermarket. And there are some price/value dimensions, too, which you'd also expect to be high up the list. But the surprise packet - for me - was the very high ranking of quality, with 'high standards of food safety', 'hygienically prepared food', 'good quality' fruit and veg and 'clean and tidy' taking four of the top nine spots, including the top one itself.

Apart from its intrinsic interest, and the insight it gives into the real nature of the supermarkets' value proposition (and, I'd guess, a glimpse of their likely strategic thinking), it's a good reminder that competition is more than competition on price. Sure, most of us involved in thinking about competition have taken the idea on board, most of the time, and there's even an acronym SPQR (Service, Price, Quality, Range) that people sometimes deploy to make sure they've got all the potential bases of competitive rivalry covered. But it's nonetheless easy to lapse into using price as a proxy for everything. In some lines of business, and supermarkets are clearly one, that could lead you badly astray, and in several directions. You could easily assume there is less competition that there actually is. And, if rivalry diminished on one of those non-price dimensions, you could easily miss that, too.

Are we getting a competitive deal - 2015 version

The Electricity Authority has done everyone a service. It's just come out with its latest surveys of the state of competition in the electricity industry and - because it needs to know whether the level of competition in electricity is good, bad or indifferent compared to other industries - in a range of other sectors. It's got two surveys, one of the general public and, if you're into electricity, one of stakeholders in the electricity industry. These surveys are a great thing to do, especially as they are now beginning to develop a bit of history: when I first wrote about them, there were only two surveys' worth of data, but now there are four, and we can maybe start to see patterns over time.

Here's the key graph from the survey of the public, which shows people's responses to the question, "Using a 0-10 scale where 0 means not at all competitive, 5 means just adequate and 10 means extremely competitive, how competitive are the following businesses in terms of working to get your business and offering you the best deals? If you do not know enough, just say so".

It's hard to know which of these results is the most intriguing. The ranking of industries is interesting: for all the concerns expressed about our supermarket duopoly, consumers evidently feel that it's a competitive one, with the the two of them duking it out in the marketplace, and they rate the deal they're getting ahead from the supermarkets a little bit ahead of the others in the survey. The low ranking of online bookstores, by the way, is because there's an unusually high proportion of 'don't know' answers, which kind of surprises me as I'd have reckoned anyone buying a book these days must have given the offshore services  a go by now, but there you are. If you're interested in the minutiae of the poll results, I've out a detailed table at the end of this post, 'over the fold' as they say.

The most recent trend, admittedly on this short series, is a little bit of a worry: except for petrol stations, the trend over the past year has been for the degree of competition to ease off a bit. Perhaps in the currently strong economy, sellers don't feel they have to compete quite as hard to earn a crust? As for petrol stations, while I'd generally go on the assumption that people are perfectly capable of making good judgements about suppliers and the deals they're offering, I'm not sure in this particular case whether motorists have been able to separate out how much of lower prices is due to lower import costs and how much to any increased intensity of competition (you might be interested in my earlier post about what's happening at the petrol pump).

These are great surveys: full marks to the Electricity Authority for running with the idea. It does, naturally, raise the question why the Commerce Commission isn't doing the same across a wider range of sectors. As I've argued before, "I reckon it's time for the Commerce Commission to belly up to the bar and tell us what real differences [in levels of competition] are happening in our markets".

And if they don't, or can't, or won't, maybe we should pirate one of the recommendations of Australia's Harper review of competition policy (if you haven't caught up with its excellent work, start here or go to the thing itself). It argued (in Recommendations 43 through 47) for a new pro-competition advocacy body, an Australian Council for Competition Policy, that would among other things "develop an understanding of the state of competition across the Australian economy and report on it regularly" (p76). It's a good idea, and we should steal it.

Finally, for anyone who wants the more detailed responses, here they are.

Australia's got the competition gospel. Have we?

At the end of last month Australia's 'Harper Review', or more formally the Competition Policy Review, issued its final report (where there are links to the chapters, the full report, and, if life's too short, a series of cheat sheet infographics which will give you the guts of the thing). I'd loved its draft report when it came out last September: it was a breath of fresh air to find a review body that was systematically on the side of the benefits of competition and against the privileged interests created, for example, by restrictions on parallel imports. In particular I'd liked its proposed change to s46 of Australia's Competition and Consumer Act, which is the equivalent of s36 of our Commerce Act, the bit that deals with misuse of a substantial degree of market power, and I was very pleased with its forthright stance against creating "national champions" shielded from domestic competition.

And there was also a whole bunch of other worthwhile stuff dealing to impediments to competition, notably (I'm quoting from the relevant cheat sheet) removing regulations that inhibit competition in areas such as aviation, shipping and taxis, and dealing immediately to archaic anti-competitive arrangements by reforming retail trading hours, parallel importing, and pharmacies. Predictably the pharmacists have responded with the usual special pleading, but there was an excellent riposte by the University of Melbourne's Prof Philip Clarke which said among other things that "the lack of competition in the sector comes at a cost to the consumer, both in terms of the choice of where they can shop and in the prices that must be paid...a packet of aspirin, which may cost as little as $3 in [the] retail marketplace costs up to $12 when it is dispensed under the PBS [Australia's Pharmaceutical Benefits Scheme]".

The final report has a few changes from the draft version (the relevant cheat sheet is here), including a new and sensible recommendation (p51) that "Competition principles, particularly those promoting choice and a diversity of providers, should be incorporated into [government] procurement, commissioning, PPP [Public-Private Partnerships] and privatisation policies and practices" and the equally sensible recommendation that "Non-employment trading restrictions in awards and industrial agreements should be subject to competition laws".

On the misuse of market power, the Review was originally minded to allow a defence that

the prohibition would not apply if the conduct in question would be both:

• a rational business decision by a corporation that did not have a substantial degree of power in the market; and

• likely to have the effect of advancing the long-term interests of consumers

but as the Review notes (p342), "This proposed defence is generally not supported by submissions", including, incidentally, our own Commerce Commission's, and they dropped it. Their final position (Recommendation 30) is

The primary prohibition in section 46 of the CCA should be re-framed to prohibit a corporation that has a substantial degree of power in a market from engaging in conduct if the proposed conduct has the purpose, or would have or be likely to have the effect, of substantially lessening competition in that or any other market.

To mitigate concerns about inadvertently capturing pro-competitive conduct, the legislation should direct the court, when determining whether conduct has the purpose, effect or likely effect, of substantially lessening competition in a market, to have regard to:

• the extent to which the conduct has the purpose, effect or likely effect of increasing competition in the market, including by enhancing efficiency, innovation, product quality or price competitiveness; and

• the extent to which the conduct has the purpose, effect or likely effect of lessening competition in the market, including by preventing, restricting or deterring the potential for competitive conduct in the market or new entry into the market.

This for me is a good finishing point, and I'd like to see MBIE, who are looking at what to do about our s36, adopt it holus bolus and move smartly on.

I also liked the Review's recommendation that the net benefits of its proposals ought to be formally modelled (they suggest, by Australia's Productivity Commission). Yes, obviously, it's rather a heroic exercise, and you'll find a discussion of the issues involved in s30 of the report (from p492 onwards), but where we can, we should all be moving to policy that's based on at least some stab at reasonable numbers rather than on wishful thinking or ignorance. I'd suggest the net benefits of their overall package could be very large: the Review helpfully included (pp497-8) some existing estimates of specific reforms, and they're sizeable. Here are a couple of them:

In respect of parallel imports (see Recommendation 13), the PC [Productivity Commission] found that, in 2007-08, a selection of around 350 books sold in Australia were on average 35 per cent more expensive than like editions sold in the US. In many cases, the price difference was greater than 50 per cent.

In regard to planning and zoning (see Recommendation 9), in New South Wales, a recent study commissioned by the state government into the potential benefits of comprehensively reforming planning and zoning in that state showed net benefits ranging between $569 million and $1,482 million per annum, depending on the reform option considered.

So hats off to the Aussies. They haven't done the political hard yards to implement it yet, but at least they've come up with a terrific blueprint for advancing a more productive, more competitive economy and for dismantling the Olde Spanish Practices that have been rorting Australian consumers.

On the other hand I wish I could see a similar appetite for reform in New Zealand. As I've said before, when another Aussie review also came up with a hatful of competition and regulation reforms, you struggle to see the same issues being treated with the same degree of urgency here at home.