Archive for the ‘Consumer protection’ Category

Energy market fail – the case for ordoliberalism

For once David Cameron has done the roughly right thing in restricting the energy companies to only four tariffs although I would have liked to see even fewer.

For years the received wisdom has been that competition – not just in energy, but generally – is a Good Thing; any evidence of that a market isn’t working properly is routinely greeted with calls for more competition.  It’s become so ingrained that almost no-one stops to question why it don’t always work as it’s supposed to.

Unfortunately for market fundamentalists, a growing pile of evidence suggests that their economic theory is wrong because it’s simply not an accurate description of how the real world works and ‘free market’ competition isn’t delivering the goods.  How this has been working (or rather, not working) was discussed on last week’s edition of ‘This Week’  with  guest Martin Lewis of Money Saving Expert (starts at 5:15).  His site has done a survey of its 14 million users and found that 80% don’t want the present system so this is political dynamite.

Martin Lewis pointed out that the energy market works as a regressive tax; affluent, middle class internet users pay the least while those in fuel poverty, disproportionately the poorest and oldest pay more, often substantially more.  He said that, whether or not Cameron really meant to say what he said on the subject recently, what he actually said is exactly what the public want, namely regulated prices.  For consumers competition has failed.

Michael Portillo reflected the uncertainty of many politicians.

“I think politicians reaching the point where they are beginning to lose faith in the ability of competition to produce the best deal for consumers but I think that is a big psychological and, kind of, philosophical moment if that’s what you actually conclude because, you know, for the last 20 years it’s been based on the idea that competition was going to give people a deal and in most things in life that’s exactly what happens. If you go to shops, telephones, if you fly on airlines, competition has brought down prices”

Note the positively baroque construction of his opening,“reaching the point where they are beginning to lose faith …“.  You can almost hear the gears shifting.  Whether he realises it or not he is calling the end of the era of neoliberal belief in the infallibility of free markets which Thatcher ushered in with her general election victory of 1979.   The old paradigm still rules by default in the absence of a better replacement but it’s mortally wounded and can’t stagger on much longer.

Portillo still clings to faith that competition reliably delivers in sectors other than energy.   However, here too evidence is piling up that not all is well with the received wisdom although, inevitably, the picture is complicated so no simple statement suffices.  I see at least three main problems (there are others but that would involve a book, not a blog post).

The first is the problem of ‘market failures’ including that markets don’t factor in externalities and that they reflect short-term supply and demand which makes them terrible where the long-term is important like planning for transport infrastructure or energy.  Market fundamentalists typically claim that market failure is rare and exceptional.  Indeed the whole basis of their faith is that ‘free’ markets (i.e. free of any government regulation) deliver optimal outcomes.

In reality, market failure is the norm.  To result in anything like a good outcome that is stable over time requires a long list of tightly specified preconditions which never, or almost never, occur in the real world.  For instance, any business sector with economies of scale (i.e. almost all) will tend towards concentration and oligopoly until the point is reached where competition is no longer effective.  The board game of Monopoly is a familiar example of how an early advantage drives growing concentration of power and inequality until it’s game over.

The second problem is that ‘free’ markets rarely exist – and then only briefly.  It doesn’t take long for oligopolistic businesses to work out how to influence the levers of power.  It helps the influencers that too many politicians are horribly star-struck and easily succumb to the glamour of money.  It can be revolving doors between companies and government, informal understandings with senior regulators and politicians, participation in standards-setting or even writing legislation.  The ways commercial power wins are limited only by human imagination – which is to say almost unlimited.  The result is the emergence of an interconnected elite.

Moreover, power abhors a vacuum so when government is weak the private sector quickly seizes an opportunity to fill the void.  If government decides not to regulate as a matter of either policy or weakness someone else will step in and the ‘law’ becomes whatever the new Mr Big says it is.   The law ran thin on the frontier of 19th century America so the theme of many westerns is the story of a big rancher employing a gang of thugs to enforce his own self-serving version of the law.  Much the same is true of Wall Street today thanks to the gutting of effective regulation as a policy choice.

The third problem is that real full-blooded competition is simply TOO effective for firms to survive it.  They must find ways of reducing the pressure on them.  The easiest way to do this is to merge with or take over rivals until the market is an oligopoly.  Hence the small numbers of serious players (typically 4 – 6) in a whole range of sectors from banking to supermarkets to energy.

It’s not that I’m against competition, far from it, but left to their own devices markets aren’t stable and won’t deliver the public policy goods.  Like advanced fighter planes the trade-off for high performance is that they are unstable.  The solution for planes is fly-by-wire systems that react faster than any human pilot ever could.

The solution for markets is the equivalent.  It’s a constant battle to keep them ‘open’ (subject to challenge) and keep them working for the public good.  This is a very different from what neoliberals advocate.

Equally, because full-blooded competition is ruinous it means that government should arrange things so that it is muted, so that there is a gentle pressure to improve and to innovate but not the imperative to eat the seed-corn to survive until next week.  That in turn means limiting pricing ‘freedom’ (aka anarchy) in sectors like energy.  And that is why I think Cameron, for once, is on the right track except I would like it to be even simpler – allow only one fixed and one variable tariff for each company with premiums and discounts for dual fuel or direct debit etc. expressed as a percentage.

This is ordoliberalsim and is the approach of most German liberals.  It’s worked rather well for them.

Retail rip-off – what the milk market should teach us about regulating the marketplace

Dairy farmers are back in the news; the processors who buy their production to sell on to supermarkets and food manufacturers want to push through a substantial price reduction that will see most farmers getting paid well below their cost of production.   Clearly this is not sustainable; if the processors succeed many farmers will be forced out of business, inter alia increasing our trade deficit in dairy products despite our having one of the world’s best climates for it.

To the extent that imports are involved I would bet a substantial amount that they are driven by lower welfare standards overseas and/or devious transfer pricing schemes whereby most of the profit ‘just happens’ (/sarc) to arise in subsidiary companies based in tax havens that provide a ‘service’ but never actually handle the milk at all.   Clearly, this is enormously beneficial to those involved but, equally clearly, it’s not in the public interest.

The problem is not that milk is ‘too cheap’.  Rather it is because well over 100% of the profit in the industry that should be equitably spread through the supply chain has been appropriated by the buyers.  (It’s over 100% since the farmers’ loss adds to the buyers’ profits).   They are able to do this because the supermarkets at the top of the food chain have the power to dictate terms so forming an effective oligopsony as described in an earlier post.   This has enabled them to pump up gross margins year by year; they rip off consumers while pretending to be their friend.

On the figures provided by the BBC adjusted to a single litre (and which are consistent with the time series included in my earlier post – see above link) supermarket make a gross profit of around 15 pence/litre which is nearly 30% of the selling price.   The BBC lamely ducks the issue of how much of this makes it to the bottom line as net profit but we can make a reasonable guess.  Logistics, store overheads etc. will all be minimal as it’s handled in bulk and sales are predictable.  Also we know (earlier post) that in the mid 1990s supermarkets got by on gross margins of only 1 or 2 pence.  So we can be very sure that the vast majority of the gross profit translates into net profit meaning that the supermarkets are achieving a ‘economic rent’ (roughly the excess profit above what they would get in a genuinely free market) of at least 12 pence per litre or around 25% of the selling price.

That is HUGE; if the margins on other goods are broadly similar (and I think many are) then this is a big part of the cost of living – especially for those on limited incomes.

So what is to be done?  If you are a plutocrat then nothing; for everyone else reducing prices raised by oligopoly is an even bigger prize than increasing personal allowances for the low paid.   Getting retail right also has a very direct bearing on other issues including Clone Towns and Mary Portas’ Review of the future of high streets.  But what can be done?

Any solution must start from the fact that the core issue is an imbalance of power.  So, for instance, suggestions that producers should differentiate their product miss the point – some limited differentiation around the edges may be possible but milk is fundamentally a commodity product.  Ditto an ombudsman or Food Market Regulator: having someone looking over the supermarkets shoulder, so to speak, may lead to limited interventions but it leaves the bad dynamics in place.

The first thing to say is that size is a problem in itself.  Retailing is a complex and demanding business but not exactly rocket science.  Nor does it require global companies with the resources required to design a new jetliner or get a new drug to market.   But it does benefit from economies of scale – largely (though not entirely) because the bigger you are the easier it is to bully producers – which means that the big get bigger and the small go extinct unless they can hang on in some niche.   Therefore left to its own devices a retail sector will evolve into an oligopoly where a small handful of large firms, all with similar cost structures, dominates the market.  In effect, regulation of the marketplace becomes privatised for the benefit of the biggest participants and freedom to evolve without limit in response to the market’s internal dynamics eventually ends in a market that is neither free nor fair.

So, the first conclusion is that the size of retailers should be limited.  This could be done in several ways, for instance by legislating that retailers must divest operations above a market share of, say, 20% in any one local authority area or 5% nationally.

The other way that retailing has traditionally been regulated is by mandating an equal price at either the wholesale level (US practice) or the retail level (UK practice).

The US Robinson-Patman Act  (and see also here) prohibited price discrimination by, in simple terms, requiring that the same price and other terms be given to all purchasers of goods for resale except insofar as the cost of supply is genuinely different.  The effect is to put all retailers on a level playing field with respect to their purchases.   The most obvious consequence is that large and small retailers can coexist which means that they are all kept honest by competitive pressure; many corner stores would think themselves in heaven to get ADSA’s margins and would gladly undercut them to increase sales – provided they could buy competitively!  A less obvious consequence is that producers who depend in large part on selling to retailers are not under the bully pressure that has characterised the UK in recent years; there is no particular advantage for a strong retailer to beat them into the ground as the retailer gets no advantage from so doing – any lower cost they negotiate has to be given equally to other retailers.  Another result is that it helps maintain a reservoir of small firms – and small firms are almost always the most innovative.

One of Reagan’s first actions on becoming President was to eviscerate enforcement of antitrust (i.e. anti monopoly) legislation to allow brute force to rule in the marketplace.   The fallout from this has been one of the biggest drivers in the subsequent growth of inequality.

In the UK regulation was accomplished by Retail Price Maintenance (RPM) until the 1964 Resale Prices Act which made most such agreements illegal.  (Libertarians ought to – but mostly don’t as far as I know – object to the RPA’s  flouting of privity of contract.)   RPM put the onus on producers to set competitive prices vis-a-vis their rivals while helping preserve a diverse retail scene but large retailers can still get better terms.  Absent RPM producers have no control over price which compromises their marketing and puts most on the back foot.   Interestingly, RPM survived for books until 1995 since when its demise has helped drive a huge concentration in retailing matched by a corresponding defensive concentration in publishing despite which most publishers are over a barrel, held to ransom by the few surviving retailers.

So, we face a stark choice; if we want a competitive market in goods we have to legislate to create and maintain a competitive marketplace.  If we don’t restore effective competition in the marketplace we can’t have a properly functioning market in goods.

 

Better than Half Price!

A short while ago my local Sainsburys had some lovely looking Scottish raspberries (yum, yum, my favourite!) with a big red sticker advertising them to be ‘Better than Half Price’.  Could this be too good to be true?  Probably!

My analytical side kicked in;  was ‘Better’ to be construed as meaning better for me, the customer, or better for Sainsbury’s shareholders?  Probably the customer I concluded but my wife insisted that it was strawberries we needed anyway.  Fortunately the strawberries were unambiguously ‘Half Price’.

But then I reflected what does ‘Half Price’ mean anyway in the context of a highly seasonal product?  Is it half the price of strawberries flown in from halfway round the World or half the price of strawberies grown in the UK in midwinter or what? 

In reality since they are packed specially for Sainsburys there is no reference price to be half of and Sainsburys can claim whatever it wants.  In the end we decided to go instead to our local independent greengrocer where a slightly larger punnet turned out to be substantially cheaper even though it was full price!

The week before it was lager.  They had a huge pile in a prominent location labelled ‘Manager’s Special’.  Great! I picked up a pack but then thought to check it against the price on the ordinary shelf (a slightly different pack size).  Good call – the ‘Manager’s Special’ was far more expensive.

Yesterday it was printer paper at WH Smith who were advertising a ream as ‘Half Price – Only £3.49 – formerly £6.99’.   It’s a while since I bought any, but I remember that when I did it was the exact same brand at £2.99.  Naughty, naughty!     

And so it goes.  To be fair I’m not picking just on Sainsburys or WHS here.  All the supermarkets (and indeed ‘Big Retail’ generally) are up to these tricks.  I go to Sainsburys because I dislike it less than Asda which is the next nearest.

However you slice it this is a deceit – and not just a minor or accidental one at that.  It’s a systematic, organized and large-scale deceit on the consumer perpetrated with the intention of fleecing him or her of the maximum amount of money while masquerading as the patron saint of low prices.

Which raises an important question.   In a liberal democracy is it acceptable for systematic deceit to be an organizing principle of a major industry, especially when it is quite clear that this is largely at the expense of customers and suppliers alike?

I think not.

Gas – Unfair at any Price

British Gas owner Centrica’s announcement of £992 million profit for the first half of 2008 only a day after putting up gas prices by an eye-watering 35% has caused predictable howls of outrage and calls for a windfall tax from left and left-leaning politicians.

This would be a mistake.  In fact only 17% of the profit is due to retailing residential gas with the vast majority coming from ‘upstream’ – i.e. producing gas from fields in Morecambe Bay and the North Sea – even though this is a relatively small part of the business.  British Gas is not allowed by law to subsidise its residential sales from upstream profits even if it wanted to for fear this would give them an unfair advantage in the market.  In the medium and long run it is far more important that they and others like them have the incentive to invest in additional energy supplies (especially renewables) that will eventually bring prices down again.

As has been observed often before, the cure for high prices is high prices.

But there is also a political issue.  The implication of a windfall tax is that the Government can redistribute it to those in fuel poverty.  This sounds perfectly fine but unfortunately it doesn’t work.  Energywatch recently said that social tariffs reach only 1 in 15 of the most vulnerable households.  And that’s before factoring in the huge bureaucratic cost involved which the country can ill-afford. 

Socialist solutions sound great but unravel when you look more closely.

However, I am very uncomfortable with the whopping £144 per annum extra paid by those on pre-payment meters compared with the relatively affluent on direct debit.  This is the result of a paradigm that says each of us should have maximum choice in each and every area of our lives.  But why?  As it happens I have just fixed our own household energy prices well ahead at the old price so I am able to be perfectly relaxed about the coming winter, but for every winner there will be several losers.  Moreover, the multiplicity of deals on offer from the energy companies makes the market quite remarkably opaque.  A good system would be one accessible to all in society and not just those with more money and/or education.

It is no surprise that society is getting more unequal under Labour.

As an alternative, why not require the energy companies to have just a single transparent tariff for all residential and small business customers (except perhaps insofar as they could demonstrate a genuine difference in the cost of supplying that customer – i.e. a set amount for the additional cost of a pre-payment meter).  ‘Choice’ would be reduced but transparency and fairness would increase dramatically, the energy companies would save a bundle on sales and marketing (and I for one would be delighted to see no more of their salesmen!!) and there would also be multi-million pound savings from not having to pay off comparison websites (I understand that each switch nets them circa £40 so their interest in promoting ‘churn’ is understandable) which would find its way back to the customer in lower prices.

And finally, with ministers and senior civil servants in the same boat as ordinary people it might just concentrate minds that need to be concentrated on, for example, why energy prices are now so much higher here than in Europe even though we have more domestic supply than almost any other EU member.

Small Earthquake in the Energy Market

Liberal Eye is feeling ever so slightly smug today.   The House of Commons Business and Enterprise Committee has been grilling the bosses of the big energy companies about rising prices and concluded as I blogged last week that the energy market is simply not working properly.  Its Chairman, Peter Luff, was all over the media yesterday with their conclusions – click here or here (audio) for details.

The MPs agree that there is no evidence of price collusion among the big six energy suppliers but note that it’s easy for each to predict what the other five are going to do on price and conclude that:

It is clear that there are very real problems in the energy markets at all levels … which need to be addressed.

In particular they are concerned that the established players are preventing new competition emerging, that UK consumers are paying more than those on the Continent and that there is a massive disparity between prices charged to those in fuel poverty (most of whom are apparently on quarterly credit tariffs and NOT on pre-payment metres) and an affluent minority who can afford to pay by direct debit.  Both Ofgem and the Government come in for sharp criticism.

In short, the MPs could hardly be more damming.

Liberal Eye notes that if you plan to take over British Energy for £12 billion you must have a pretty clear idea of how much you think its future earnings are worth and this in turn depends on future prices.  So if  two energy companies are jointly negotiating to take over a third there must have been a great deal of sharing of thoughts on prices.  This is sailing perilously close to the wind.  (The definition of a cartel is what precisely …?) 

At first glance this is the sort of story that a headline writer might summarise as “Small earthquake in Westminster – no-one Injured” .  However, this would be to wholly miss the real significance of this story.   The headline should read “Small earthquake fatally undermines dam foundations – creates crisis“.  The reason?  The Labour Government, like the Conservatives before them, have put their faith in creating competitive markets in the industries they privatised.  The market would, they promised, keep prices competitive and through its ‘dead hand’ protect the public interest with just the lightest of light-touch regulation to keep things on the straight and narrow.

This plan has now palpably failed and the market fundamentalists’ delusion stands exposed as a fallacy nearly 30 years after it became the dominant economic meme in the Thatcher/Reagan era.  That is why I regard the emergence of these problems in the energy market as fundamental.  It undermines the very foundations of the ‘market fundamentalist’ cognitive policy that has shaped politics over the last 30 years.  (In passing it’s worth noting that similar issues exist in other sectors – banking, retail, public transport etc.  The public are again the losers paying greatly over the odds for most of what they buy).  The Government will, of course, soldier on trying to patch and mend as they go but it will be to no avail.  It is effectively impossible for a Government to change cognitive policy mid-term so we must wait for a new one.

So here’s a prediction: whichever Party first manages to articulate a convincing alternative to market fundamentalism will sweep all before it.  But will this be the Conservatives who like to think they understand economics (but got us into this mess in the first place) or the Lib Dems who tend not to like to think about economics at all (thus securing their record as easily the most unsuccessful Party of the twentieth century)?

Needed: better regulation

For as far back as my political memory goes ‘regulation’ has been a dirty word.  Of course, this hasn’t stopped politicians reaching for new regulations and regulators at every opportunity (would it be too cynical to say in response to every tabloid headline?)   

Unfortunately the QUALITY of regulation is not matched by the QUANTITY and as a direct result the government has problems at every turn.

First to blow was Equitable Life on which the Parliamentary Ombudsman has just reported.  As Paul Braithwaite of the Equitable Members Action Group (EMAG) put it:

The UK regulators were fully aware for a decade that Equitable Life was effectively insolvent, yet they allowed the company to suck in another £20bn in pension contributions from more than a million new investors.

Quite reasonably they want some of their money back.

This is hardly small beer, but only a curtain-raiser for the credit crunch that broke open last summer.   This is the direct result of the fact that for many years major banks were operating what amounts to a Ponzi Scheme – a fraud involving paying abnormally high ‘profits’ to investors out of the money paid in by later investors rather than from any underlying real business profit.  Needless to say the regulators are supposed to stop this sort of thing but appear to have been too busy checking the petty cash to notice what was going on leaving the banks free to devise cunning ways to wriggle free of any regulation so that much – in some cases most – of their business escaped the regulators.   Inevitably this has ended in tears; we are all poorer as a result and will be living with the consequences for years to come.

Then just yesterday the BBC carried this story reporting that the lack of certainty over the value of university degrees is “descending into farce”.   This involves far less money but is perhaps the most serious of all for it strikes directly at the life chances of a generation.  All of us, students, taxpayers and employers alike, should be able to rely on the fact that a British degree means what it says on the tin.  Anything else is tantamount to fraud.

So what conclusions do I draw?  Simply this; we need good regulation for the safe and efficient functioning of the the complex world we live in.  But not too much or quantity will drown out quality.

Not such Good Value

We all know that British supermarkets are highly competitive and give outstanding value for money.  And how do we know?  We know because they told us so.

 

If you smell a rat you are right.

 

What we actually have are 4 near-identikit firms who maintain an illusion of competition but actually have no real interest in duffing each other up and every interest in maintaining a system that suits them just fine.  What they actually do is to use their size and power to roll over and squelch any upstart competition that emerges so ensuring that real competition is minimised and that they are left with free reign to beat up their suppliers and achieve ever greater margins.

 

As Cheshire dairy farmer Ray Brown told the BBC:

 

“If you [the farmer] are lucky you get 26-27 pence per litre, it’s the same price as we were getting 11 years ago.

 

“Supermarkets have a big score to settle there. The consumer then was paying 40 pence per litre, currently they are paying 57-58 pence.”

 

He’s absolutely right.  This means that consumers are being overcharged by a minimum 45% by the supposedly ‘competitive’ supermarkets (and that’s only using the reference point of 11 years ago).  Could there be any clearer evidence of market failure?  Could there be any clearer justification for a strong anti-monopoly response from Govt?

 

I think hard-pressed families (and farmers!) deserve some answers and some action.

 

In this context the publication yesterday of the latest investigation by the Competition Commission is yet another depressing example of the utter uselessness of the established system of regulation (see also Northern Rock etc).   Predictably, and in line with established form, the results will not worry the supermarkets.  Not that they actually wrote it as such but they do seem (as David Boyle suggested recently in this excellent piece on monopoly) to have successfully framed the issues in ways that play right into their hands.  It’s appears that in the rose-tinted World of the Competition Commission the supermarkets are basically virtuous and hence deserving of all possible support—which they are naturally pleased to give with just the lightest possible rap on the knuckles.

 

For instance a principle plank of the CC’s proposals is that planning applications for new stores or store extensions should be made subject to a ‘competition test’.  At first this seems reasonable until you stop to think that using Planning to address a Competition issue is basically barmy.  Moreover, it does nothing to address established local abuses—for instance Tescopoly reports that Tesco is the dominant retailer in 67% of postcode areas and has a greater than 50% market share in 5 areas.  (In contrast note that the CC had earlier concluded that over market shares of over 8% lead to abuse).

 

Another main plank of the CC’s proposals is that a supermarket ombudsman be appointed to oversee and where necessary enforce a stronger code of practice for dealing with suppliers.  Predictably the supermarkets are engaging in heavy breathing and talking ominously of costs of “hundreds of millions … which could be passed on to the consumer”.  To say this is a bit rich in view of their soaring margins on for instance milk is an understatement.

 

Actually, I too am opposed to the idea of a revised code of practice but for a very different reason.  It’s an administrative solution for a problem that requires a market solution and as such it simply won’t work for its intended purpose—although it might well provide lots of new civil service jobs!

 

David Boyle is absolutely right—Lib Dems should make this issue their own.