The fur is flying in Oz - and maybe will here, too

We're in the process of having a rethink about our 'abuse of market power' legislation - s36 of the Commerce Act (if you're new to this you may want to have a quick read of 'The law is an ass' and 'Get your views in on abuse of market power').

It's partly because the Aussies have also got the ball rolling. In fact, they're ahead of us, as the Coalition government over there has decided to change the Aussie law, in line with the recommendation by their 'Harper review' of competition policy, while we're still at the consultation stage. The gist in Australia is that the law will switch from a focus on the purpose a firm with market power may have had when it did something, to a focus on the effects the firm's actions have on the competitive process.

I think it's a sensible move, and I've been arguing for doing the same here. We currently have pretty much the same wording in our law that the Aussies have decided to change in theirs, and we can get a free ride on their (very extensive) process of competition policy development. And if the Aussies change, we don't really have much choice in the matter, as we'd be left high and dry with an ineffective archaism of our own.

In Oz, however, the proposed change has sailed into a new political squall. Reform of important legislation affecting big business always tends to have its tricky moments: what set it off this time was a comment by Australia's Productivity Commission in its recently released draft report on agricultural regulation (if that's your thing, the overview is here and the full report here). Along the way the Commission had said (p431)

Some competition law experts argue that pressure to amend section 46 [the Aussies' version of our s36] is based partly on wanting to shield small businesses from competition. For example:

Section 46 is designed to ensure those with market power don’t use it to insulate themselves from competitive pressure; but s46 shouldn’t be used to insulate small business … (Trindade, Merrett and Smith 2013, p. 6)

The introduction of an ‘effects’ test to section 46 is unlikely to shield farm businesses from intense competition in retail grocery markets. Shielding farm businesses from competition would also not be in the interest of consumers.

What the Commission said, in short, is that even if the effects test was enacted, it wouldn't actually serve as protectionism for farmers, and in any event protecting groups from competition would be a bad idea. All good.

But then up pops a press release from the Opposition competition spokesman Dr Andrew Leigh, quoting that bit from the Commission saying an effects test won't help farmers and adding

An effects test won’t protect producers, but it will raise grocery prices and threaten retailers with court action if they become too competitive...Labor remains opposed to the effects test as it will have a chilling effect on competition and raise prices on everyday groceries such as bread and milk

He also went on, rather incongruously for a Labor politician I thought, to recycle a number of anti-effects-test statements from the big business end of town, and finished by arguing that the effects test was in reality a plot by the National Party component of the Aussie Coalition to protect small businesses against competition from large ones.

The notion that the proposed law change, intended to increase competition by preventing anti-competitive standover tactics from those with market power, was actually A Cunning Plan to decrease competition by protecting small businesses, has predictably sent the proponents for change well-nigh berserk.

Ian Harper, who led the Aussies' 'Harper review' of competition policy that came up with the proposed change, responded by telling The Australian newspaper* that the effects test "has been misinterpreted to an “almost wilful” degree", that "characterising the proposed reforms as protectionism was “to turn reality on its head”", and that "The point of the act is to protect the competitive process, not individual competitors".

Rod Sims, the chair of the ACCC, who supports the change to an effects test (and who has also supported our Commerce Commission in pressing for the same change here), was even blunter. He said, again in The Australian*, that "framing section 46 reform as protectionist policy driven by the National Party is “bullshit”, and has slammed big business for distorting debate around the so-called effects test laws", and "Sure, they’re (the Nationals are) in favour because they like the little guy being able to compete with the big guy. But that’s what we want: we went competition, everybody should want competition. We don’t want large companies preventing competition.”

I wouldn't be in the least bit surprised if something like this bunfight plays out here in New Zealand, too. It might be a step too far for our Labour opposition to rise in the House to champion the rights of the supermarkets and other big firms, but in the opposition for opposition's sake game that both our big political parties play, who really knows. I just hope that, in the end, the Harper and Sims views make it through the political minefield.

*I haven't included direct links to The Australian articles because there's something of a random process around The Australian's paywall - you might get through, but you might not, either. If you google 'Ian Harper slams ‘effects test’ reform critics for distortion' and 'ACCC slams big business for effects test distortion', you can usually find access either to The Australian site or to other sites that have carried the articles.

Time to revisit "hard core" cartels

Earlier this week the European Commission fined four truck makers €2.93 billion (NZ$4.6 squillion at the current exchange rate). A fifth, the German company MAN, wasn't fined because it ratted the others out, and under the Commission's cartel leniency policy (and our own Commerce Commission's), the first company in the door to renege on the others gets off any fine (though it and its cartel mates remain exposed to civil suits for damages). A sixth company, Swedish based but Volkswagen controlled Scania, didn't settle with the Commission and is being pursued separately. Full details here.

This was your classic "hard core" cartel - secret, prolonged (14 years), deliberate, and significant. As the European Competition Commissioner said

there are over 30 million trucks on European roads, which account for around three quarters of inland transport of goods in Europe and play a vital role for the European economy. It is not acceptable that MAN, Volvo/Renault, Daimler, Iveco and DAF, which together account for around 9 out of every 10 medium and heavy trucks produced in Europe, were part of a cartel instead of competing with each other.

The European Union hasn't criminalised cartels, meaning that executives can't be jailed. Member countries weren't prepared to give the Commission the authority, and have gone their own ways: some have chosen the criminalisation route (the UK, Ireland), most haven't. But if ever there was a European case where executives needed to have their collars felt, this was it.

By coincidence, a couple of days earlier the ACCC announced that NYK, the Japanese shipping company, had pleaded guilty to criminal cartel conduct involving the shipping of vehicles from Japan to Australia in 2009-12. It's been a while coming: this was the first criminal case since the Aussies criminalised cartels in mid 2009. We don't know who the other alleged parties to the cartel are. We don't know if anyone at NYK is packing their toothbrush.

When I see cases like these, I can't help thinking - again - that we made the wrong decision last December in flagging away cartel criminalisation in New Zealand. I've posted before that "Hard core" cartelists are criminals and what our response should be: Let hard core cartels off the hook? Nah.

Bear in mind that I'm a bleeding-heart raised-in-the-Sixties liberal, and I'm hard to convince that we should imprison people for anything short of grievous bodily harm or broadcasting reality TV programmes. Bear in mind, too, that I'm generally pro business, strongly pro markets, and slow to buy into heavier regulation or enforcement without an industrial strength, convincing, evidence-based case. But when these genuinely "hard core" cartels crop up, even I am prepared to reach for the handcuffs.

Get your views in on abuse of market power

Right - you've got till 5.00pm next Thursday, June 21, to get your views in to MBIE on their targeted review of the Commerce Act.

It's important, and while I know we've all got other things to do, you'd be doing the economy a favour if you took some time out this week-end (when you're not watching the Warriors take on Manly in Perth, 7.30pm Saturday) to make a submission, particularly on our current approach to abuse of market power - the infamous section 36 of our Commerce Act.

All the background and how to submit can be found here. While technically MBIE is calling for 'cross submissions' on earlier input, anyone can put in something from scratch, though for good form you should probably phrase it as being a response to something already on the record.

There are three issues being canvassed, one big, one medium, one small.

The big one is potential reform of s36, the abuse of market power provision of the Act. In my opinion, and others', the thing is banjaxed. The law is poorly designed, has been interpreted strangely by the courts (both the old UK Privy Council and our newer Supreme Court), and in practice allows behaviour to go unchallenged that would not be countenanced in jurisdictions with better arrangements.

If all this is news to you, read the paper I gave at this year's NZ Association of Economists' conference, 'Abuse of market power: the end of "make-believe" analysis?'. If you'd like to see opinions saying no, everything's hunky-dory as it is, you'll find them in the original set of submissions to MBIE (try the law firms' ones). Whichever way you go on the issues, get your opinion on the record: these issues are too important to be left to 'the usual suspects'.

My cross-submission (I put in a submission first time round, too) is going to be along the general lines of my recent post on s36, 'The law is an ass', and will say:

• Our competition authority, the Commerce Commission, has given up on making the current regime work despite having identified instances where it thinks there have been potential abuses of market power that it is unable to address

• Its Aussie equivalent, the ACCC, agrees with it that our system is munted

• The law is poorly phrased in the first place

• Hence and otherwise the jurisprudence on s36 has seen the legislation effectively gutted in all but the most egregiously awful cases. In particular, courts are supposed to ask, would a firm without market power have done the same thing, and if so, the firm with market power is home free. This completely subverts the whole point, that some actions when undertaken by firms with market power have anti-competitive effects

• The Aussies have, rightly and after a very extensive consultation process, decided to change their law (it's currently similar to ours) for something better

• When the Aussies change, it will be silly and inefficient to have companies facing different legislative tests on either side of the Tasman, and we should harmonise on the better Aussie approach. Harmonisation is a government priority in any event

• The arguments against change - broadly in  the categories of 'business certainty' and 'potential chilling effects' - while valid, are not strong.

There are two other issues you might want to look at.

The medium sized one is whether someone - probably the Commerce Commission - should have the ability to go out and proactively look at the state of competition in a particular sector. The short answer to that, is yes, of course it should. If you want a very quick potted summary of the case for, try my post 'The case for market studies - again', and if you'd like something more comprehensive there's my paper at last year's NZAE conference, 'Is the competition toolkit missing its torch? The case for market studies'. 

The smaller one is around the Commerce Commission's enforcement powers, and especially the 'cease and desist' process. I'm very sympathetic to some kind of quick-response tool for competition authorities, but there are arguments that the current 'cease and desist' process isn't working the way it ought. This is probably one for the lawyers amongst you.

On your marks, get set...

The law is an ass

My paper, 'Abuse of market power: the end of "make-believe" analysis?', drew a good crowd at the NZ Association of Economists' annual conference. That's partly because people like to session-hop at conferences and listen to areas outside their usual specialty - a fair few in the audience were folks who don't usually 'do' competition - and partly, I'd guess, because people reckon it's an important policy issue: markets won't work as we'd want them to, if competition is subverted by players with market power.

From the discussion, it was clear that people were left shaking their heads at the folly of our statutory wording (in s36 of the Commerce Act) and its subsequent jurisprudence in the courts. Very briefly, the folly consists of:

• statutory wording that looks for a 'purpose' to knacker competition and the 'taking advantage' of market power, but
• 'purpose' is subjective (barring careless e-mail trails) and often business behaviour has multiple purposes, many benign, which can veil the bad stuff, while 
• 'taking advantage' has been interpreted by our courts as meaning you're home free if you've done something that a firm without market power would have done
• which completely misses the point that something done by a firm with market power can have very different effects than the same thing done by a firm without market power, and
• leads to an examination of what would have happened in a fantasy counterfactual world, and
• nowhere looks at the important issue of what are the actual or likely effects of the behaviour in the market, and
• Australia's just come to the view that their regime (very like ours) is not fit for purpose, and 
• in sum the whole shebang comes close to giving firms with market power a free pass on pretty much anything that isn't the most obvious of rorts.

But you knew that (and if you didn't, there's chapter and verse in the paper).

The reason I'm raising it again is that there's an opportunity for people who may be concerned about the current toothless (and internationally idiosyncratic) state of affairs to do something about it.

Last year, MBIE started a 'targeted review of the Commerce Act', which included looking at the operation of s36. An initial issues paper drew 39 submissions. But now there's an opportunity for cross-submissions: you don't have to be one of the original submitters to get into the fray. You have till July 21 to get any views you've got into the policy pot. Full details of the process thus far can be found here, including links to the previous submissions and the logistics of submitting your own.

I'd emphasise that this isn't an anti-big-business agenda. The primary point here is the proper functioning of markets, for everyone's benefit, businesses and consumers alike. The big loser from anti-competitive behaviour is often other businesses.

In any event, get your views on the record. If you're not in, you can't win.

Competition is good for you, part 294

My post on how competition has been improving productivity and lowering prices in both Australia (retailing in general) and New Zealand (electricity) didn't go down well with everyone. One commenter on Twitter said that it was all very well for companies to try to become more efficient to cope with increased competition, but "In their desperation for competitiveness, where do the retailers push employee wages? Down. Migrants & casualisation".

As it happens, there hasn't been a lot of research on the distributional effects of greater competition: a big survey last year done by European Commission staff, 'Ex-post economic evaluation of competition policy enforcement: A review of the literature' found (p29) that

When a lack of competition raises prices and reduces the quality of products, it causes damages to all consumers, including the poorest people. In this context, it could be interesting to analyse the distributional effects of market power. Existing evidence seems to suggest that an increase in competition is particularly beneficial for low-income people. However, the literature in this area remains in its infancy and there are a number of topics deserving further research.

But as luck would have it, along comes some new research, 'Competition policy and inclusive growth', which has had a crack at looking at the distributional impact of increasing competition (through the various effects of  the European Union's policies against anti-competitive mergers and cartels). Their bottom line is that "Interventions have important redistributive effects that benefit the poorest in society", and here are some of the key numbers. The model captures the eventual economy-wide effect of a 'mark-up' shock (a setback to producers' profit margins from competition enforcement) on different groups in society.

You can see that there are more jobs, and higher wages, for rich and poor alike, but poorer households' consumer spending goes up a good deal more than rich households' (because poorer households of necessity save less). And the rich unambiguously lose through the reduced profitability of the companies they, as the shareholding class, own.

I wouldn't necessarily go mad about this: these are early days for this kind of research, and the type of DSGE model used, while the bee's knees in modern modelling circles, can be a finicky hothouse contraption. But the results are exactly what you'd have expected: rolling back anti-competitive market power is good for consumers, and for poorer consumers more than richer. I'd draw an analogy with the producer market power created by protectionism: the poorer are disproportionately affected by the higher prices of the things that are typically 'protected' most (food, clothes, shoes). And it stands to reason that the poorer will be worst hit by any anti-consumer development: they had the least choice to begin with, whereas the rich have more options.

In any event we should know a bit more in the near future: this work was part of a conference the World Bank ran last year on 'Promoting Effective Competition Policies for Shared Prosperity and Inclusive Growth', and there's apparently a conference volume on its way.

Finally a hat-tip to the Vox website, the policy portal of the Centre for Economic Policy Research, which published these results. It's a terrific compendium of timely, wide-ranging, practical research, with something to say (in readable, short format) on all the important issues of the day. Highly recommended.

Competition is good for you, part 293

The Reserve Bank of Australia came out with its latest Quarterly Bulletin the other day, and in it there was a fascinating article, "Why Has Retail Inflation Been So Low?".

The authors wanted to find out why inflation in the Aussie shops was running lower than would have been expected, given the level of the Aussie dollar, as can be seen in the graph below, where the dark blue line (inflation)  has been lagging below the pinky-purply one (the changing value of the A$).

And when they looked at it more closely they discovered an interesting thing. They disentangled what happens when exchange rates change. There are two steps: the first is the impact on the landed Aussie cost of imports (which goes up when the A$ falls and down when it rises), and the second stage is what happens to that changed landed cost of imports as it works its way through the wholesale and retail domestic distribution chain.

What they found was that the first stage hadn't changed at all: a lower A$, for example, was still feeding through to higher landed A$ costs of imports, just as it always did. But the second stage had changed quite a lot: from about 2010 onwards, there was less pass-through of those higher import costs into final consumer prices, as the graph below shows.

They weren't able to nail what had changed in the second stage using econometric methods, other than to confirm that statistical tests did indeed confirm a change in behaviour, so they had a qualitative fossick instead, based on what the RBA had been picking up from its regular programme of going round and talking to businesses ('liaison' in central bank geekspeak).

Increased competition appears to have been the reason (my emphasis added):

Liaison with retailers suggests that over the period of interest, competition in the retail sector has intensified, partly due to increased supply. There are numerous sources of this increase in competitive pressures, although some key themes have emerged from liaison.

• Technology has enabled consumers to compare retail prices quickly and easily online and determine which retailer(s) are offering the lowest prices. The increasing online presence of traditional bricks-and-mortar retailers is contributing to this effect.

• Relatedly, the supply of retailers has increased due to competition from foreign online retailers. This was particularly evident over 2010–13 when the exchange rate was relatively high...Over this period, domestic retailers became relatively less competitive against competitors based offshore.

• Both established firms and new entrants, including international retailers entering the Australian market, are competing aggressively to gain market share

They also found an interesting phenomenon where in a number of sectors, there was an especially aggressive competitor who was making life tough for the rest of the players:

In a number of market segments, liaison has attributed the increase in retail competition to the actions of a perceived ‘market leader’, which is generally looking to expand their market share, effectively increasing supply. This has led a number of retailers to report that they believe demand for their goods is very price sensitive, and fear that they will lose sales volumes if they increase prices. Earlier work on Australian retailers found that a majority of firms primarily set prices based on the balance of supply and demand factors, such as market conditions or competitors’ prices, rather than setting prices as a fixed mark-up over costs

Competition in turn was forcing firms to improve their efficiency if they wanted to maintain previous levels of profitability, pushing them to look for "labour productivity gains through technological improvements, such as contactless payments systems, self-serve checkouts and better monitoring of staffing needs" and "other means, such as bargaining for lower rents, improving inventory management, sourcing from fewer suppliers, partnering with other firms to lower distribution costs and centralising some administration tasks".

What a nice textbook outcome from increased competitive pressures: consumers have got a better deal, and producers have been pushed to improve their productivity. And it comes in a week where the latest instalment of MBIE's electricity price monitoring showed that retail electricity prices had dropped for the first time in 15 years, which MBIE said "was driven by increased discounting activity and incentive credits" - greater competition, in other words. Carl Hansen, the CEO at the Electricity Authority, said that the price fall "is one of the many indicators of strong competition in [the] residential electricity market. Another indicator is that smaller retailers have now grown their market share to 10 per cent which is putting significant pressure on the larger retailers".

It may be making a meal of the obvious, that competition is pro-consumer and pro-productivity, but the message doesn't always get through in New Zealand, or elsewhere. The lobbyists for the quiet life in sectors such as education, health and the professions are good at running the pro-producer line, and (like in bunfights over trade protectionism) the voice of the consumer doesn't get the hearing it should.

We need more competition across more markets, and you don't have to take just my word for it. The OECD, in the chapter on New Zealand in the latest update of its Economic Outlook, said that "Reducing barriers to FDI [foreign direct investment] and to competition in the electricity, transport and telecoms sectors would facilitate greater investment and innovation, increasing productivity and reducing prices". There's work to do if we're going to have the retail price and producer productivity benefits Australia is enjoying, and more of our utility bills going down.

Quick reactions to the Z/Chevron decision

The decision is out and it's pretty much as outsiders would have picked (and I should add I'm an outsider, not having advised any of the parties involved) - the likelihood always was (at least for petrol stations) that it would be either a clearance with divestments, or a decline, and we've ended up with a split decision, a 3:1 majority for clearance with divestments (19 petrol stations and 1 truck-stop), with one vote for a decline.

We don't have the full written decision yet, but the press release says the sticking point for the split decision was the possible increased risks of price coordination. The majority thought that "the loss of Chevron would make no material difference to this behaviour given its passive role in the market as a wholesale supplier. The likelihood of Chevron being an effective constraint on coordination in the future is low, even if sold in the future to another party". Dr Jill Walker in dissenting felt that "there is evidence of tacit coordination between petrol retailers in some regions, primarily where Gull is not present, and that this has contributed to increasing margins in the petrol industry" and that "the permanent removal of Chevron’s assets as an independent supply chain means its potential to disrupt coordination is gone and this behaviour would become more firmly entrenched post-merger".

I had three immediate reactions.

My first was that I was pleased to see a split merger decision: there haven't been many of them (the last one, from memory, was Ezi-Pay in 2012, which was a split decline). Yet the merger applications that come into the Commission these days tend to be complicated and borderline beasts, and frankly it would be very surprising if everyone invariably saw them the same way. For me split decisions suggest there there is indeed that "robust mix of viewpoints represented around the decision table" that I mentioned earlier this week.

My second was a quiet wonder to myself whether Australian and New Zealand attitudes to mergers (and arguably to competition issues as a whole) might be diverging: the majority were Kiwis, the dissenter the Aussie cross-appointee to the Commission. Could be entirely happenstance on the facts of this case, or it could be that the Aussies (rightly or wrongly) are taking a more hardball (or conservative, pick your own word) to competition risks. Sometimes the Aussies in my view go too far: I'm not yet persuaded, for example, that their actions to stop the supermarkets giving out very large petrol discount vouchers ('shopper dockets') were necessary. And some might argue that it's fine for the two jurisdictions to take different lenses to issues. All the same, it's probably best, if only to make trans-Tasman mergers more predictable, if there's a consistent perspective on both sides of the ditch. Perhaps there is, and the split-by-nationality is of no significance. Or perhaps there isn't, in which case it might be useful to explore how the two countries' regulators think about issues such as price coordination and the loss of potential disruptors, and how you assess economic evidence on the issues.

My third reaction is one that won't surprise readers of this blog, and that is the absurdity of the Commission's limited powers to look at the state of competition in markets. In this case, the Commission examined "whether coordination was already occurring in the retail [petrol station] market": it pointed out that even if it were, it may not be anything illegal, and that "The behaviours occurring in the retail fuel markets in New Zealand, such as price following, regional pricing differences and rising margins, can occur in both coordinated and competitive markets".

But it also said that "The majority of Commissioners consider it is possible, though not definitive, that coordination is occurring in some local markets. However, where they may have had the most concerns about coordination occurring post-merger, they consider the divestments remedy those concerns". Dr Walker, however, was not convinced: as noted above, she felt it was happening already.

The stupid thing is that this behaviour - potential, suspected, actual, benign, malign, whatever - only got examined because, fortuitously, a merger came in the Commission's window and triggered a look. The Commission has got no formal power to have a look off its own bat, even though it has a very good feel for where these coordination issues are likely to arise, and would know where to beat the bushes. I've gone on and on about the need for the Commission to be able to conduct 'market studies': it was already screamingly obvious that they should (assorted process issues can be dealt with), and this latest decision is yet more evidence why there's a problem. The government needs to get off its chuff and fix it.

An insider's view of mergers

Last night's LEANZ seminar, 'An Insider's Reflections on Merger Clearances', was a cracker. David Blacktop, the Commerce Commission's Principal Counsel, Competition, has seen merger proposals from both sides of the fence (he was at Bell Gully previously), and there's not a lot he doesn't know about the principles and the process.

First, David gave us some data. Currently the overall 'decline' rate from the Commission is about 10%, though if an applicant gets to the knotty 'letter of unresolved issues' stage (and 11 out of 54 applications ended up in that particular 'this is a really hard one' basket), the odds of a decline are about 50:50 (6 cleared, 5 declined), which is what you'd expect. Whether this is too low, too high, or just right is anyone's guess, but as there have been some people arguing that merger clearances (at least in the US) may have got too lax (as I discussed here and here) I asked him what you need to do, as a merger regulator, to guard against inbuilt biasses. His sensible answer was, ensure there's a robust mix of viewpoints represented around the decision table.

David also gave us some good data on timeliness. The time to process a decision has been rising - David joked that it coincided with his arrival, and I joked that it timed with my departure - but as David said, the simple 'average' across all applications of somewhere in the low 60s in working days (12 or 13 calendar weeks) doesn't really give you the proper flavour. Relatively straightforward ones get done in 43 working days (8-9 calendar weeks). 'Letter of issues' ones have the letter issued on working day 38, and get put to bed in a total of 71 working days (about 14 calendar weeks). The knottiest 'Letter of unresolved issues' ones have their letter issued on day 72, and take 107 days to a clearance and 108 days to a decline (with the extra day to get the reasons for the decline written up right), or some 21-22 calendar weeks.

There may be some internal resourcing issues - the regulation side of the Commission has been taking up a fair chunk of availability - but the most likely explanation (in my view) is that the longer time to a decision is largely the result of recent ones being both more complex and more borderline in their competition effects. The biggie currently inhouse - Z Energy/Chevron - rings both bells, and (assuming it comes out tomorrow as indicated a while back) it will have taken ten months from start to finish.

David also highlighted a somewhat unusual feature of some recent merger declines. Two of them were very similar - specialised businesses built up in provincial towns, with the owner looking to retire and sell the business in a trade sale. Trouble is, in many of these situations, the only trade buyer is highly likely to have a local monopoly. And the legal costs of getting to a decline will be disproportionate to the value of the business and the size of the local market.

So, what do you do? Should we have some minimum dollar threshold, below which the merger regulator will simply not be bothered - even if this leaves some provincial town paying over the odds in some (probably small, probably specialised) markets? Instinctively you think, that's not very equitable, but realistically you also realise that the costs of the full process are completely OTT for these situations. My own feeling, having been involved in some of these decisions, is that it's often going to be the case that over the longer haul there's only room (in a minimum efficient scale sense) for one provider in many of these towns, and that what looks like a merger of two to one is effectively bringing forward what was going to happen in any event. If an applicant supplies evidence showing that, across New Zealand, there's typically only one specialist provider in towns of that size, the merger regulator should be more ready to press the green button.

David raised a number of other interesting ideas. For example, do we have a sufficient range of potential remedies to cope with potential merger detriments, given that divestment is a blunt instrument? And where are we in terms of transparency and confidentiality? We ran out of time to get into that issue properly, but for what it's worth I think we could, without prejudicing commercial confidence, expose a bit more of the process, particularly around letters of outstanding and unresolved issues.

Another excellent LEANZ evening - and it makes me think (again) that the NZ Association of Economists could usefully have an equivalent series of seminars on other topics. Well done to all involved, and special thanks to James Mellsop and Will Taylor* at NERA for hosting the event. Let me know when you're opening some more Akarua Rua Pinot Noir.

*11/05/16 An earlier version got Will's name wrong. Apologies.

Is market power on the march?

Last week I wrote about a piece in the Economist which made a case that corporate profits had become too big in the US - too big in the sense that the rise in profitability was more down to an unwelcome easing of competitive pressures (including through mergers of competitors), and a consequent rise in market power for incumbents, than down to any underlying efficiency gains or customer service improvements. My take was that if it's a potential issue for the US, it's potentially an even bigger issue for us if it's also happening here, as we're already an economy with high degrees of market concentration in various sectors. It would consequently be a good idea to see if we have (for whatever reason) become too relaxed about giving clearance to mergers, and have been allowing through ones that had actually resulted in a substantial loss of competitive pressure.

And it's like buses - right after the Economist, along comes the Council of Economic Advisers (CEA) in the US saying much the same thing in their 'issue brief', 'Benefits of competition and indicators of market power'. It's not a hard or a long (14 pages) read, but if life's too short you'll find a pretty good summary here, from the Stigler Center at the University of Chicago Booth School of Business. It also covers President Obama's consequent executive order, asking the American public sector to come up with specific ideas that would boost competition.

Where I've got to, after reading this latest effort and some of the sources it references, is that I'm in the same place as I was before. There's suggestive but (as yet) nowhere near knock-out evidence for the US, but if it's even a realistic prospect there, we need to be on our guard here that we haven't got a more severe case of it, and in particular that we aren't making the condition worse by inadvertently nodding through mergers that will reduce competition.

Let's look at some of the evidence. The CEA led off with this.

I
Well, yes, concentration is up, but often not to levels that ought to be in the least bit worrying: these are revenue shares for the top 50 companies combined, and they're often at entirely non-threatening levels. The CEA had to start somewhere, I suppose, but you'd need something a lot stronger to get to "there's a problem" territory.

The CEA do however reference some studies at a market level (which is the right frame of reference) which suggest it's happening there, too, and sometimes to levels that would indeed give you pause for thought. And other folk tend to find the same general trend, for example this paper on listed US companies concluded (p33) that

the decline in the number of industry incumbents is associated with remaining firms generating higher profits through higher profit margins. The results suggest that the increase in profit margin cannot be attributed to increased efficiency but rather to increased market power. Second, mergers in industries with a decreasing number of firms enjoy more positive market reactions, consistent with the idea that market power considerations are becoming a key source of value during these corporate events. Finally, firms in industries with a declining number of firms experience significant abnormal stock returns, suggesting that considerable portion of the market power gain accrues to shareholders. Overall, our findings suggest that despite popular beliefs, competition could have been fading over time

Of course, if you buy the idea that market power is on the rise, there could still be a bunch of reasons for it other than competition regulators not catching the anti-competitive impact of mergers, including (as both the Economist and the CEA mentioned) increased regulatory barriers to entry. It could be technology, for example: this graph from the CEA shows the already most profitable companies becoming even more so. But note that the acceleration in the top performers' ROE starts to take off mid-1990s, just when all the internet-enabled stuff started to take off. Are these the Googles of this world, and/or the companies outside the IT sector that made the best use of the new technologies?

And the CEA piece also shows that the US regulators have not been asleep at the wheel. The chart below shows that the US competition authorities have, rightly, been spending more of their time on the big (above US$1 billion) mergers than they used to. Proposed mergers ("Hart-Scott-Rodino transactions") over about US$78 million get notified to them: the regulators start "second request investigations" if they think there might be competition issues. In 2000, some 6% of proposed mergers were US$1 billion or more, and they accounted for about 25% of the push-backs from the regulator. In 2014, the big ones made up about 14% of all mergers, but were responsible for nearly 50% of the regulators' queries. If anything, you could make the case that the regulators had been spending a disproportionate amount of their time on the smaller stuff in 2000, and have got their act together since. They could, of course, still be letting "too many" through, but it's not obviously for want of kicking the tyres in the first place.

Where does this leave New Zealand and our policies and practices?

First of all, there's the law, and the Commerce Commissioners have got to call it as they see it, merger application by merger application. If they're "satisfied" that there's no substantial lessening of competition - that's the legal threshold - then it's game on. But, almost by definition these days, the proposals that come in the door are knotty. Getting to "satisfied" isn't easy. And to get there, I think Commissioners and their staff advisers would want a good deal of info to hand on trends in New Zealand corporate profitability and industry structure - what sort of 'natural experiments' are we seeing, for example when the third player in a market falls over, leaving just two? - and in particular they'd want to know what had happened when mergers "like" this one went through in the past. Against this background, ex post analysis of previous merger decisions is crucial.

Which, by the way, is also where Gary Rolnik, one of the professors at the University of Chicago's Booth School, has got to. No, there's (as yet, anyway) no smoking gun that excessive concentration and anticompetitive mergers are the issue: "these claims need more empirical studies before we can conclude, like The Economist, that for S&P 500 firms these exceptional profits derived from undue market power are currently running at about $300 billion a year, equivalent to a third of taxed operating profits, or 1.7 percent of GDP". But there's a real risk they might be: "the growing anecdotal evidence from many industries and the persistence of high profits margins in the face of stagnant growth and growing inequality deserves serious consideration".

We need to know, too. I can think of a lot worse projects for (say) our Productivity Commission to turn its mind to.

A hypothetical question

Suppose an overseas supplier of video on demand services is annoyed that customers in other countries are using Virtual Private Networks (VPNs) to access its domestic catalogue. Those customers are perfectly happy to pay the supplier's domestic pricing, and they're doing so because the supplier's service in their own countries is limited and/or more expensive.

Suppose now that the overseas supplier gets together with (say) credit card companies, and together they agree that the card companies will not process the customers' payments to the VPN companies.

If any of this were to affect New Zealand customers, do you think it would be "a contract or arrangement ... containing a provision that has the purpose, or has or is likely to have the effect, of substantially lessening competition in a market"?

Are mergers going too far?

A few weeks ago the Economist ran a leading article, 'The problem with profits' (here's a link, but it may be paywalled). It argued that

The naughty secret of American firms is that life at home is much easier: their returns on equity are 40% higher in the United States than they are abroad. Aggregate domestic profits are at near-record levels relative to GDP

It also said that

incumbent firms are becoming more entrenched, not less...Our analysis of census data suggests that two-thirds of the economy’s 900-odd industries have become more concentrated since 1997. A tenth of the economy is at the mercy of a handful of firms—from dog food and batteries to airlines, telecoms and credit cards. A $10 trillion wave of mergers since 2008 has raised levels of concentration further

and argued for a policy response:

take aim at cosseted incumbents. Modernising the antitrust apparatus would help. Mergers that lead to high market share and too much pricing power still need to be policed

I ran the numbers myself on the level of US profits relative to US GDP, and here they are (using the excellent FRED database). Pre-tax profits (the red line) tend to be the headline number, but the better measure is after tax profits with statistical adjustments for stock valuation and depreciation (the green line).

On one measure, profits as a share of GDP had been in long-term decline from the early 1950s up to about 2002-03, on the other (better) measure profits had been steady over the same period, but they both agree that profits have indeed taken off since. The GFC made only a temporary dent, and the drop in recent quarters may be equally transient as it reflects the impact of plunging energy prices on the US energy sector (notably on the 'fracking' industry) and it too may well dissipate if oil prices continue to firm. Overall, yes, the profits share has risen to a historically high level.

The hypothesis that overlax, Type 2 error, policing of mergers - allowing ones through that have ended up substantially lessening competition - isn't proven. But the possibility that it might be, ought to give competition authorities serious pause for thought. It's possible that economic and judicial thinking on mergers has indeed swung too far in the pro-merger direction. 

At one point in the US it had been right down the other, Type 1 error end, disallowing mergers that were extremely unlikely to cause any competition issues: classic errors of that kind had included the Brown Shoe case in 1962 and the Von's Grocery case in 1966. In the grocery one, Von's and its intended merger party would have had 7.5% of the highly unconcentrated Los Angeles market between them. Since then, opinion has evolved, less weight is put on pure market share numbers, and more, rightly, on whether there will be still be effective constraints on the merged entity post-merger. Mergers reducing four market participants to three, or three to two, will still receive intense scrutiny, as they ought, but they can get the tick today in a way that would have been unthinkable fifty years ago. Even two to one may get approved in exceptional cases.

But it may be time for a rethink, especially because (as the saying goes) you generally can't unscramble the eggs if you've mistakenly let an anticompetitive merger go through. And the downside risks are probably a bit higher in New Zealand since a fair few of our markets are fairly concentrated already. As it happens, there's a particularly good example in the pipeline right now, with Z's proposed purchase of the Chevron petrol stations. It's a doozie, or, as the Commission put it in November, "The merger application is complex and involves a number of markets throughout the fuel supply chain. We have identified and notified Z Energy of several areas that we are continuing to investigate...Further work is also required to investigate the retail supply of petrol and diesel, as there are a number of retail sites where, if the merger proceeded, few options would remain for consumers". I wasn't in the least bit surprised that in December the Commission gave it itself another four months to mull it over (the indicative decision date is now April 29). It's a tough one.

If it's indeed the case that merger authorities risk erring down the Type 2 end - and we may be at particular risk because of the structure of our economy and its Z/Chevron decision points - then it gives added force to the arguments for evaluating merger decisions after the fact. There are some folk who say it can't be done, mainly because (they argue) you can't tell what the counterfactual would have been if the merger had not gone ahead. I'm not among their number, and neither, latterly, is the Commerce Commission, which, as I noted here, has creditably gone back and looked at how they've been turning out.

The more I think about it, though, the more I'm beginning to wonder whether an independent third party shouldn't do the job (or at least be co-opted into the Commission's evaluations). I've got a good deal of confidence in the Commission's people and processes, but even so it's generally not a good idea to make one of the players the referee. And if merger authorities everywhere have accidentally strayed into allowing too-big mergers, it probably needs someone outside the consensus groupthink to say so.

Then and now

I've just finished the second volume, Everything She Wants, of Charles Moore's authorised biography of Margaret Thatcher. It covers 1982-87, and it's excellent. Whatever your political views are - and many people will be starting from a strong opinion about her -  you're likely to end up with a more balanced view. The first volume, Not For Turning, was equally good, and won multiple industry prizes.

From an economist's point of view, it's interesting to look back on the economic policy of thirty years ago. One particularly striking aspect was the bizarrely uncoordinated way of running fiscal policy, or as the book puts it (p185)

Under the British system, the Budget is not a Cabinet decision, though the Cabinet is perfunctorily consulted and informed before it is unveiled to Parliament. It belongs exclusively to the Chancellor [of the Exchequer], and 'The only person the Chancellor is obliged to consult is the Prime Minister'

Some other aspects of fiscal policy also looked questionable. One of the motivations for asset sales was the cosmetic effect of appearing to reduce the fiscal deficit by counting the sales proceeds as current revenue - a bad practice. And monopolies such as British Telecom (BT) were sold off to maximise the sale price, with inadequate controls on subsequent profiteering. Not that the UK was alone in taking the money and running - as recently as 2002, the Australian government sold off Sydney Airport on terms which effectively prevented any rival airport getting underway.

The big UK Budget set-pieces also reminded me that once-a-year adjustment of revenue and spending looked odd even back then, and has become even more anachronistic since. There may be some reasons why you can't adjust fiscal policy day-by-day (people would have some difficulty staying on top of their tax owing, as would the IRD in collecting it), but on the other hand there's been a big step forward in automating the likes of payroll systems over the past thirty years, and some of the supposed constraints on more frequent than annual tax or spending changes may well have dropped away. And there's certainly no good reason why (say) increased infrastructure spending has to wait till May 16 (our Budget date this year) for the starter's pistol to go off.

Monetary policy was relatively primitive. Early on the Thatcher government set out on a tough anti-inflation squeeze - my first mortgage, which I took out in the UK in 1979, was on a fixed 14% rate - and ran policy by trying to manage one or more of the monetary aggregates (typically 'sterling M3'). But Goodhart's Law kicked in, and Chapter 13 consequently deals with 'The death-knell of monetarism'. Monetary policy as we mostly know it today - with an independent central bank and an inflation-targetting regime - didn't arrive in the UK till 1997, under an incoming Labour government with more modern ideas.

Not that everything back then was ramshackle. The UK took a trick with a politically adroit way of allocating shares in British Telecom - "Everyone applying for 400 shares or fewer got 100 per cent of what they sought. Those who applied for 100,000 shares or more got nothing" (p198) - which sat nicely with the 'popular capitalism' aim of the sale, and which might be worth revisiting if we ever get round to future privatisations (that 45% stake in Kiwibank, maybe?).

And the Thatcher government (belatedly) came up with regulation for the likes of BT that was state of the art, including Professor Stephen Littlechild's 'RPI minus X':

This was not supposed to be the ultimate answer to the monopoly problem, but was more of a stop-gap measure until sufficient competition developed. As matters turned out, however, it stopped a great many gaps, and became a regulatory model for other privatizations (p196)

I think it can still plug a great many gaps, and I'm not sure we (and other countries) are doing a better job with highly complex and expensive 'rate of return' alternatives.

I was also reminded of the then closed, snobbish, sexist nature of the City of London, where a provincial, middle class woman with a science degree like Margaret Thatcher was, not to put too fine a word on it, outright despised:

[Cecil] Parkinson recalled meeting her returning from lunch at a big bank before her first victory in 1979. 'They had given her hell. She was very depressed. I said: "Don't worry; they'll vote for you, and they'll forget it". "They may", replied Margaret, "but I won't"' (p215)

Final words to the inimitable Denis Thatcher who was accompanying Mrs Thatcher at a Commonwealth conference in India:

At this conference, Denis's irritation with the physical arrangements boiled over. During the leaders' 'retreat' in Goa, there were constant power cuts. He emerged on the balcony of the chalet allotted to the Thatchers and bellowed: 'This place is very high on the buggeration factor' (p548n)

The Aussies are winning the competition policy game

Yesterday the Australian government announced that it is going to follow the recommendations of the Harper review of competition policy, and change the bit of the Aussie competition law - section 46 - that aims to prevent anti-competitive abuse of market power. It's going to change to being based on an "effects" test - did the powerful firm's behaviour have the effect of damaging the competitive process? The current system, which focusses on the purpose of the powerful's firm's action, will be junked, and with it will go the whole legal palaver over whether a firm "took advantage" of its market power, and which has required going through a fanciful "counterfactual" exercise of whether a firm without market power would have done the same thing. Now, all that will matter is whether the opportunity to compete has been compromised - the effect. As it should be.

The Aussies have made exactly the right call. They're right when they say that

Australia’s current misuse of market power provision is not reliably enforceable and permits anti-competitive conduct. This slows the entry and expansion of new and innovative firms, delays the entry of new technologies into Australia and impedes economic growth in the long term

and right again when they say

this reform represents a commercially and legally robust law, preventing firms with market power engaging in behaviour that harms the competitive process. It places Australia’s competition law on the right footing to encourage economic growth and innovation

and I wouldn't mind if more governments came out and said

Protecting the competitive process is unashamedly pro-competition and allows everyone to have a go.

This has a variety of implications for New Zealand.

As I've argued before (here or here), I think the Aussie have got their act together on competition policy - commissioning a wide-ranging review, finishing it quickly, and adopting most of the decisions including (as we've just seen with their s46) some of the politically trickier ones. Earlier, the Aussie government had said it wasn't immediately going to change s46 as Harper had recommended, which was widely interpreted as fear of the big business lobby's reaction: the big end of the town was against the change, for a variety of principled and self-interested reasons. But the Turnbull government has correctly and (in defiance of the Sir Humphrey Applebys of Canberra) courageously faced down the political opposition. The Aussies are no shining angels on everything - they've been wusses about proper liberalisation of second-hand car imports, for example - but they've stolen a march on us here.

At home, we have run a much less comprehensive 'targeted review of the Commerce Act' which, to be fair, did include a review of options for changing section 36 of our Commerce Act, our equivalent of the Aussies' s46 (and yes, I did make a submission saying we should go the way the Aussies have just gone). As for timeliness, the targeted review is still in the bowels of MBIE somewhere, and we don't know what it will recommend or when, or whether our government will go with whatever it comes up with.

You'd think our government would be daft to leave us as the only jurisdiction in the English-speaking world still hanging onto the economic and legal make-believe world of the "counterfactual", let alone - given that they're been banging the drum about harmonising trans-Tasman institutional arrangements - allowing a large gap to develop between our competition law and the Aussies'. But on the other hand I'm not fully sure our government is ready to take on potential big business opposition in the way the Aussies just have. Ours has, for example, flagged away criminalisation of cartels: yes, you can make a principled (though wrong) case for doing that, but it could as equally be symptomatic of paying close attention to whatever big business had been whispering in your shell-like. We'll see.

The only thing that slightly irks me about what the Aussies have done is the way they've represented it as a small business versus big business policy. It's been widely represented the same way in the media (here or here, for example). Now, I understand the politics of it - if you're going to brass off big business, then you'd better court the compensating small business vote, and anyway it plays to the long-standing "Aussie battler" meme. But it's not the best way to think about it: a better way is to recognise that anti-competitive rorts are as likely to rip off a big business as they are you or me. A business can be very big indeed, and still get ripped off when, for example, the fix is in (as it was) on the cardboard boxes it needs. Effective competition benefits us all - big and small.

A New Take on Competiton

There are tons of people out there who have great ideas for new startups. However, most of them never actually act on them. Obviously, there are many different reasons for this. For some it may be because they lack the time, others do not want to take any risks, and some possible entrepreneurs are discouraged because there is already another company in the market that does a similar thing. 

At the end of the day, these are all valid excuses. But that is all they are. Excuses. If you really want to start your own business, you will have to face all the issues mentioned above. You will find hardly any entrepreneurs who feel like they have time to spare, or who did not have to take any risks. And most importantly, you will never find any entrepreneurs who will tell you they don't have competition. And you know what, that is a good thing. 

Just think about the very basic things you do with your company. Maybe you are selling a certain product. Fair enough. But why do people buy your product? It's pretty simple. They buy it because it satisfies a need. So at the end of the day you are not only offering a product, but more importantly you are offering a way to satisfy needs. This is a critical change of perspective. 

If you look at your business from this perspective, you will soon realize that you are not only competing with companies that offer the same product, but with a whole bunch of other companies that offer seemingly different products as well. For instance, if you are selling ice cream on a hot and sunny day, you might think that you are mainly competing with other ice cream sellers. But that's not quite right. In fact, you are also competing with the kid next door who sells lemonade. 

Most people buy ice cream because they feel like they need a sweet refreshement. Both ice cream and lemonade could potentially satisfy this need. So if your potential customers chose to buy lemonade, they are probably not going to buy ice cream from you anymore. Because you know, that too much of that sweet stuff is unhealthy, right?

This thought can be pursued even further. If your potential customers have access to a swimming pool they have other means to cool themselves down and get a refreshing experience, so they might not even feel like eating ice cream anymore. So even products from a whole other industry might compete with your products. 

Now, this may appear rather intimidating if you are thinking about starting your own business. Why even bother if there are so many competitors? It's simple: because competition proves that there is a need. If there is nobody who satisfies the same needs that you are targeting with your product, in most cases there is no need for it either. Literally. This is important to keep in mind. Even if you are the first one who comes up with a new product, there are probably others that target the same needs. 

Of course that does not mean your idea is not new or innovative. It actually means that you might be on to something. If your product is able to satisfy the same needs better than the existing products (from other companies or industries) then you have a chance to be successful. You "just" have to be better. In fact, this is how most disruptive innovations start. 

Just keep that in mind next time you talk to a potential investor. They will always ask about your competition. Whatever you do, don't tell them you don't have competition. Talk about the needs you are targeting, how you are targeting them and why that's better than what is being done at the moment. There is no such thing as no competition.

In a nutshell

Companies are selling products and services. More importantly however, they are selling ways to satisfy needs. This is a critical change of perspective. If you look at your business from this point of view, you will soon realize that you are not only competing with firms that offer the same product, but with a whole bunch of other companies that offer different products but target the same needs. Even if you are the first one who comes up with a new product, there are probably other competitors that satisfy the same needs. So at the end of the day competition is a good thing because it proves that there is a need for what you do.

Let hard core cartels off the hook? Nah

The reactions to the news that cartel behaviour will not, after all, be criminalised, have been all over the place.

I covered the initial reactions from the law firms most involved in competition law here as well as my own reaction, where I was disappointed that "hard core" cartels were not going to be criminalised (I only chose the law firms, by the way, because they were first to react, not because I was climbing into them); John Small has written 'Criminalising cartels' which doubted the rationale for the non-criminalisation decision; Bernard Hickey has criticised the decision (this version has more comments but this version has prettier graphs); Paul Walker has written 'Do we need competition policy?' and 'Competition policy, again (updated)', broadly questioning the case for criminalisation and taking a critical approach to interventionist competition policy in general; and Jim Rose has written a thoughtful piece, 'Does competition law in high-tech markets help consumers?' which is less about the criminalisation issues but more (like Paul) thinking about the scope of competition law particularly in modern more tech-based economies. No offence to anyone I've missed.

Over at the New Zealand Dr Oliver Hartwich also came out with a piece, "Three cheers for competition (and for Paul Goldsmith)", which welcomed the non-criminalisation news. But I have real difficulties with some of his arguments.

Here's one of them:

The problem lies in the nature of competition law. It is an area of law which is prone to arbitrariness. Practically everything is a matter of interpretation...In short, the nature of competition law is such that you would never want to make it the basis of criminal sanctions. Criminal law requires a great degree of predictability. If you commit a crime, you should know what penalty to expect if caught. With competition law, you often do not even know you have done something wrong until a judge tells you so

Now, I've some sympathy for this argument in some contexts, and have said so in the context of 'abuse of market power': where s36 of our Commerce Act might or might not apply, and megabuck fines might or might not be in play, it's a fair point.

But as I said then, "there will be instances where there are guys in black hats who know they are wearing them", and "hard core" cartels are the classic example. The people engaged in them know there are no 'efficiency' or 'collaborative activity' benefits. They know full well that the sole purpose is to rip off unsuspecting buyers of their products. And if you think those old style, smoke-filled-room cartels belong back in the days of Teddy Roosevelt's trust-busting US of A, and things like that don't happen anymore, then you haven't been following the international case law*.

A second argument Dr Hartwich makes is in the same general area of fuzziness of the law:

Then there is the difficulty in finding proper definitions. To quote the late economist Murray Rothbard, “there is nothing anticompetitive per se about a cartel, for there is conceptually no difference between a cartel, a merger, and the formation of a corporation: all consist of the voluntary pooling of assets in one firm to serve the consumers efficiently.” Indeed. Yet somehow the formation of a corporation is fine whereas a merger or a cartel might be illegal.

Rothbard's argument is surreal. They're self-evidently not the same, and self-evidently do not have the same effects. The formation of a corporation very likely involves the creation of no market power; a merger of two businesses might or might not create market power; a cartel almost certainly does.

And to say that they all different routes to the same objective, "to serve the consumers efficiently", is false in the case of most cartels, and absolutely, blatantly, spit-in-your-eye false in the case of the "hard core" cartels I'm most concerned about. They are by definition inefficient from an allocative efficiency point of view - consumers don't get to buy the quantity they would have liked to, at the price they'd be happy with, in the way they would have in a workably competitive market - and very likely inefficient from a dynamic efficiency point of view. For example, I can't see cartelists putting much effort into innovation that might undermine the product they've got a stranglehold on.

But pulling back from some of the detailed arguments, let's take an overview.

A lot of the comment has been along the lines that free-market people who are generally in favour of letting businesses get on with their business without too much interference - and I don't have a problem with that as a general approach - ought to be glad that a potential piece of heavy-handed business legislation has been rolled back.

Let me give you three reasons why I think that, as a general approach, is wrong in this instance.

The first is that cartels interfere with the proper operation of markets. You can't be a believer in letting markets rip and in standing idly by when cartels swing into action. Market prices are supposed to be signalling consumers' demands and producers' opportunities. They're not, when the prices are getting stuffed up by cartels. That's why proponents of markets (like me, and competition authorities everywhere) get so hot under the collar about them.

The second point is - for folks who genuinely worry that criminalising cartels, or even prosecuting them under our present civil law arrangements, risks penalising possibly welfare-enhancing collaboration and 'chilling' things consumers would have gained from - is that (a) we already have a route for companies to justify 'good' cartel arrangements (John Small's post was very good on this) (b) the proposed Commerce Act changes are introducing another one, and (c) the criminalisation proposal (as was) had an 'out' for making an honest mistake.

Let me explain. You form a cartel (I'm using 'cartel' to cover all the cartel-like behaviours, not just price-fixing). If that's all you do, you're toast. You're bang to rights under s30 of the Commerce Act. It's deemed, out of hand, to be a malign substantial lessening of competition.

But you can, under the Act as it stands, apply under s58 to have your arrangements 'authorised'. This means going through a process where you show that what you're doing may have some competition downside, but it's outweighed by the benefits. You'll see a good example here: the Commission authorised the Infant Nutrition Council's Code of Practice "which restricts advertising and marketing of infant formula for children under six months of age", "restrictions on advertising and marketing may lessen competition", but "the public benefits arising from higher breastfeeding rates outweigh any lessening of competition from the arrangement".

The proposed changes to the Commerce Act introduce another, 'clearance', channel. 'Clearance' is where you get the Commerce Commission to agree that there's no competitive detriment in the first place, so you don't even have to go through the balancing of detriment and benefit exercise. This clearance route, incidentally, is the standard way many proposed mergers get the nod.

But wait, there's more. As the Commerce Committee said (on p9 of the proposed changes), "criminal sanctions should be reserved for conduct that is truly culpable. A person should have intended to engage in the conduct in question, or at the very least have been reckless as to its consequences, to attract such sanctions". Quite so, which is why (see p6) people could have used an "Honest belief" defence, namely "they honestly believed that the cartel provision of the contract was reasonably necessary for the purpose of the collaborative activity...The term “reasonably necessary” requires the exercise of judgment in which a person could make an honest mistake".

This looks to me like quite an extensive suite of opportunities for people to argue their case for a pro-competitive cartel and, in extremis, escape having their collar felt if they've accidentally and honestly strayed over the line. And it still leaves the worst of the worst liable to have the book thrown at them, which is as it should be.

The third point for pro-business people to ponder is that, very often, it is other businesses that bear the brunt of hard-core cartelists' ripoffs. While there is no 'typical' cartel, a very common example is a cartel for some industrial input. You may see comments floating around at the moment about cardboard packaging, which is a reference to one of our closer to home cartels, the Amcor/Visy rort which stitched up the market for cardboard cartons, a mainstay component for many manufacturing and distribution businesses. As the ACCC pointed out, "The Federal Court ordered Visy and Amcor to pay $95 million in damages to a customer class action involving more than 4500 businesses".

Incidentally, I highly recommend the ACCC's 'Cartels case studies & legal cases' resource (which is where the quote came from). If nothing else, it's going to shake any unthinking assumption you may be holding about the harmlessness of cartels.

And with that I'm almost done. I'll just add that I'm somewhat taken aback. I was expecting more reactions along the lines, "Some cartels are beyond the pale. They are disgusting, exploitative conspiracies. I condemn them. I strongly advise everyone not to go there. But there's a whole bunch of activities that are more difficult to categorise..."

I'm still waiting.

*You might want to read Robert Marshall & Leslie Marx's book, 'The Economics of Collusion: Cartels and Bidding Rings'. It's excellent: as my long suffering colleagues in the economics trade will vouch, I've been wishing it on everyone. It's also readable by non-economists, as the authors have deliberately structured it for the intelligent lay person. The details of the lengths cartelists have been prepared to go to defend their conspiracies are an eye-opener.

"Hard core" cartelists are criminals

Earlier this week the government said that it is flagging away criminalising cartels. The rationale was "the significant risk that cartel criminalisation would have a chilling effect on pro-competitive behaviour between companies": in other words, businesses could be put off from engaging in worthwhile cooperation for fear of straying into heavily penalised criminal territory.

Most of the reaction to the news was either positive or matter of fact.

Buddle Findlay said they had always opposed criminalisation, for the very reason the government has now recognised. They also felt that there had been a side benefit from the whole exercise: "While the need for prison jumpsuits for cartel conduct no longer exists, the threat of criminalisation has been a significant factor in renewed compliance training and focus for New Zealand businesses.  In our view, the threat of criminalisation by itself has been critical to deterring anticompetitive behaviour".

Simpson Grierson reported the news without taking any positions, though they picked up on something else that also might have gone off the government's radar - the proposal to bring the shipping lines under the Commerce Act. There is, of course, no good reason for shipping line cartels to be exempt from the competition law of the land, any more than there was any good reason for IATA, pre 1980, to run a global airline cartel.

Minter Ellison Rudd Watts said the change in tack would be "welcome news for businesses which have expressed strong concern about the potential chilling effect that criminalisation could have on legitimate pro-competitive activity". They also, correctly, said that "Criminalisation is a controversial issue, not least because of the difficulty in evaluating its deterrent effect", pointing out that for various reasons actual criminal prosecutions in Australia and the UK have been thin on the ground (I'd also spotted the Aussie development).

And Chapman Tripp's consultant Grant David said in the NBR that dropping criminalisation was a good idea, but there was a better reason for it, which was "the question should be whether it is appropriate to subject executives to serious risk of imprisonment for conduct that is uncertain in nature and can be deterred in other ways" (here's a link but it may be paywalled if you haven't signed up).

My own take is somewhat different. I've been left with distinctly mixed emotions.

There's the bleeding-heart liberal part of me that welcomed it. The western world - particularly the US, but more generally - is getting overfond of redneck policy, long on retribution and short on rehabilitation and prevention.  In that light, one less criminal sanction on the books isn't a bad idea.

And there's the economist part (and the barrack-room lawyer part) of me that can see the government's point about potential chilling effects on cooperation, particularly as other proposed changes to the Commerce Act were simultaneously making collaborative activity easier to organise. Easing up on cooperation on the one hand, and (arguably) making it more uncertain on the other, didn't make for a completely coherent policy package.

But.

But on the other hand I have a deep, visceral dislike of "hard core" cartels, as they're often called in the competition enforcement business. These are the premeditated, concealed, hijackings of the competitive process: the ones with the coded messages, the throwaway mobile phones, the maps with the cartel members' territories, the furtive meetings in hotel rooms on the fringes of trade meetings in Osaka or Düsseldorf or Buenos Aires. These go beyond the concerns economists or lawyers might have about the affront to competitive markets: they are concerns every citizen ought to have about the proper operation of their society. "Hard core" cartels are in the same general territory as fraud and embezzlement, and ought to attract the same penalties.

Self-evidently, these sorts of rorts would never have been confused in the conspirators' minds with licit collaboration.

So I regret that the proposal, along with grey area "is it cooperation or is it collusion" activity, will also let the "hard core" cartels escape criminalisation. It can't have been beyond the wit of statutory draftmanship to have carved out a description of "hard core" cartel behaviour, and criminalised it, just as there are gradations of other bad behaviour (murder/manslaughter, reckless/dangerous/careless driving).

Let's get serious here. Piddling offences not worth the courts' time are prosecuted every day. But "hard core" cartels,  about as obnoxious and harmful as it gets when it comes to white collar crime, escape the dock. It's not right.

Good progress by the Aussies

Sometimes you have to admire the Aussies.

First they had the gumption to realise that competitive markets are part of the answer to an economy working better, and to do something about it. As their Federal Treasurer Scott Morrison said this week, "Competition policy is one of the surest ways to lift long-term productivity growth and generate economic benefits that can be shared by everyone". And they set up a competition policy review - the 'Harper' review- that delivered good results in short order with modest resources. Now, this week, the Aussie government has said it's going to run with the majority of the Harper recommendations - 44 out of the 56 - and has 'an open mind on' or has 'noted' the rest of them. Nothing's been rejected out of hand, or at least that's the official line, though I suspect the odd one here or there will be quietly left to expire. There's an item-by-item list of responses here.

It's not the most important of the Harper recommendations, but I was particularly interested in how they would react to the one on allowing 'market studies', proactive inquiries into the state of competition in markets. As I posted this week, I think this is an open and shut case: they're an obviously useful - maybe even necessary - part of the competition toolkit. The Aussies have come to the same conclusion. It's not entirely clear (to me at least) whether the Aussies will be running market studies solely through the ACCC (which the response to Recommendation 45 suggests) or whether they will also be done by a new body, the Harper-recommended Australian Council for Competition Policy, which will shepherd the general competition reform agenda. Either way, market studies are a goer. We don't (I reckon) have the scale to set up an entirely new body ourselves, but the sooner we get to the commonsense position of the Commerce Commission doing market studies in New Zealand, the better off we'll be.

Many of these agreed recommendations have the potential to make important improvements to Australian productivity. The big ones include getting more choice and competition into social services; making sure that regulation doesn't unnecessarily restrain competition (taxis/Uber look like getting dealt to, as well as mandatory product standards); ensuring that local authorities' zoning and planning doesn't have anticompetitive outcomes; and improving and simplifying competition law ("a prohibition on concerted practices, refining exclusionary conduct provisions, simplifying cartel laws, streamlining merger clearances, introducing a class authorisation process and establishing more flexible collective bargaining provisions"). And there's a long tail of smaller good ideas which will cumulatively add to the positive impact.

Not all of them are signed, sealed and delivered. A lot of the recommendations will still have to be worked through with the Australian states. And some of the more difficult ones have been kicked for touch - pharmacy reform, second-hand car imports, and, especially, reform of s46 of the Aussie competition law, the equivalent of our s36 of the Commerce Act, which deals with the abuse of market power. It hasn't gone dead - "the Government will consult further on options to reform the provision and release a discussion paper on this topic" - but there's clearly a major political bunfight on the way between Big and Small Business, complicated by political flak (the Aussie Labor Party isn't behind the Harper s46 approach). Here's a good article from the Sydney Morning Herald that gives a feel for who's backing what.

Even so, it's obvious that over the next wee while Australia will be building up quite a head of competition reform momentum. And it puts our limited exercise - the recent 'Targeted review of the Commerce Act' - in the tuppenny ha'penny place by comparison. We've already got a bit of an issue in trying to close the productivity gap with Australia: we're going to have to do a lot more in the competition arena if the Aussies aren't going to pull even further ahead.