The illusion of competition

Hello world. My posts on this blog have been sporadic, I’m generally moved to write by economic activity and the global economy (Africa excluded) has been, by and large plodding along in its sluggish manner. There has been no breakthrough policy shift; no ideological shift away from the current set of policies, rather, a continuation of what we’ve seen, which is public sector cuts and the detrimental consequences of such actions.

What this prolonged period of economic activity has shown us is the fact that profits will always by certain sections of our society. Despite policies that have had a nefarious effect on large sections of our community, profits have been made and if we look at the market structure of the firms making profits then it is clear that they mainly resemble oligopolies and monopolies.

Before I explain the ramifications of this apparent anomaly, I should stress that I am not here to lambast profit making. Profits are a sign of an efficient business, whereby costs are controlled and a business can expand. Without profit business would not exist, not only would there be no incentive to innovate and take ideas to market, but a firm would have no means in which to continue producing their good or service. In an ideal world however, profits would be generated in a naturally competitive market. And a competitive market has no room for oligopolies and/or monopolies to form.

My previous pieces here and here show how oligopolies are bad for consumers because they allow firms to charge whatever prices they feel suitable, leaving consumers with no choice. What is so distasteful is the fact that goods and services that are essential to our wellbeing are the ones where competition is non-existent and legal barriers are erected in order to prevent newer entrants from challenging established firms.

It may be coincidence but as the weather gets cooler the utilities market seems to increase prices and this year is no different. If we look at British Gas, one of the largest firms in this market, they are increasing gas by 8.4% and electricity by 10.4%. Ian Peters of British Gas admits it is “unwelcome news” but in an industry where there is no effective competition comments such as his could act as a condescending reminder of the contrasting fortunes of our increasingly divided society. Whilst I do not doubt the sincerity of his comment, it comes during an extremely difficult period of stagnant economic activity, where households have been forced to cut spending therefore demanding less. Comments such as his can only add insult to injury. The Energy Secretary Ed Davy was not pleased, adding that the price increases in general were “extremely disappointing news.” He and the Prime Minister advocated that consumers “shop around” for the best deals. Therein lies the fundamental problem. Even if consumers switch from one energy company to another the market structure itself dictates similar prices, thus the savings are marginal at best. For savvy consumers looking to save every penny (and in this climate, who could blame them?) this is a restrictive option. It should be noted however that collusion in any oligopoly is either deliberate (which is illegal) or tacit. So firms will mimic their rivals.

Source: BBC

The formation of the energy cartel in the UK is an explicit example of market failure. Market failure is where the free market fails to effectively distribute resources efficiently. In order for governments to erode this failure there are a number of political and economic tools it could utilise in order to help correct this failure. Governments often spout the notion that markets are regulated. Regulation is a surrogate form of competition that probably disrupts the flow of business activity as oppose to aiding it. What governments should do and what they claimed they were doing when they privatised several important industries was ensure that market power cannot become concentrated into the hands of a few large firms. This has not happened. Rather, the inefficient government owned industries have been replaced by the inefficient privately owned firms. In fact, when government owned them they had to answer to the taxpayer, now these firms answer to shareholders, the stakeholders i.e. consumers have no say. Their acquiesce is a formality.

The same situation is prevalent in transport where prices will rise again in January by 4.1%. Again the traits are synonymous with other oligopolies, consumers have no choice.

Powerful firms often use branding as a way to create the illusion of competition. Branding allows consumers to associate that good or service on its own merits, but as the diagram below highlights, rather poignantly, so few firms actually have substantial control over goods and services we have to demand.

The 10 major food companies

I began this piece by stating that profits are still being made by sections of our society. I am not advocating for some quasi profit distribution to the lower echelons of society. I am however suggesting that the public demand much more from national government. Where oligopolies are formed, governments should be pressured by the public to erode the legal barriers preventing a number of newer entrants challenging the dominant firms. Until actual competition is established and markets resemble a monopolist market structure, where there a lot of firms and new entrants can enter the market easily, prices in essential industries are only going to go in one direction.

Is Justice Reinvestment a viable solution to the UK Prison Crisis? Part 1

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The following is part one of a special look at the prison system in the UK. The prison population is near full capacity and incarcerating criminals is an arduous and expensive process. Justice Reinvestment seeks to allocate resources away from building and funding of prisons and looks to invest resources into greater societal schemes that could prevent crimes in the long term.

Justice Reinvestment (JR) is a simple concept, reallocating resources away from prisons and investing funds into societal schemes. The resources invested are aimed at eradicating the problems that lead onto criminal activity before they manifest. That should result in the long-term reduction of the number of incarcerations. The prison system in general is wasting resources and failing to tackle the long-term problem of reoffending.

There are currently 84,000 prisoners in the UK, full capacity, despite household and violent crime falling by 46% since 1995. Sentencing has not followed in the same direction. The inverse relationship between the drop in crime and rise in incarcerations highlight the odd relationship between high sentencing and fall in crime. Crime has fallen yet more people have been sent to jail.

Clearly the current prison situation is both inefficient and ineffective as greater emphasis should be devoted to criminal prevention rather than punishment, tackling the act once it has occurred may “solve” the crime, but the greater problem of why an individual or group have committed the crime itself highlights the need for a substantially greater understanding of crime prevention. The current prison system does not tackle crime prevention very well.

Philanthropist George Soros and his firm Open Society first expressed concerns with regard to similar problems within the US penal system, Allen and Stern suggest,

“George Soros has been questioning the cost of maintaining the current unprecedented level of imprisonment in the US and asking whether a redirection of resources away from criminal justice and into social, health and educational programmes might not make a more effective long term contribution towards creating safer and stronger communities.” (Justice Reinvestment – A New Approach to Crime and Justice 2007)

The concerns raised here share similarities to those being expressed in the UK, hence why JR could provide a realistic solution to the current penal crisis.

The prison crisis in the UK is the manifestation of both the latter stages of the John Major government (1990-1997) and more significantly Tony Blair and Gordon Brown. (1997-2010.) The manifesto promise of not only being tough on crime and more significantly the causes of crime, the current prison crisis has not benefitted from their efforts.

“On crime, we believe in personal responsibility and in punishing crime, but also tackling its underlying causes – so, tough on crime, tough on the causes of crime, different from the Labour approach of the past and the Tory policy of today.” (Labour 1995)

The idea of JR would appear to adhere to the Labour manifesto of 1995 that promised to act on the causes on criminal activity. The proactive approach is likely to provide remarkable knowledge on reoffending. The data could prove pivotal for identifying patterns and relationships between the criminal and their background. Identifying certain traits in societal behaviour would provide insightful knowledge on reoffending and resources would be in place to tackle it directly.

The crisis could be viewed as a simple problem of demand being greater than supply. Half of all prisoners reoffend. This has increased pressure on the prison system to reduce overcrowding so that prisons not only punish, but educate, rehabilitate and reform prisoners so that they can reintegrate themselves back in society reformed and not reoffend. Currently, resources are at full capacity and the prisons are struggling to provide those services due to the sheer numbers of incarcerated. The revolving door culture with criminals is putting further strain on the troubled economy. JR provides insight in reducing the long-term problem of high reoffending. This is by no means a short-term solution; it requires a more long-term approach and immediate reoffending rates are not likely to fall dramatically. However, what JR would provide is an in depth understanding of the why reoffending is so high.

No room left.

For several years tough on crime or zero tolerance translated into imprisoning record numbers of criminals. Also, building more prisons appeared to offer the solution to the growing demand for prison space. All of this occurred whilst criminal activity was falling. In hindsight, it would appear that the government at the time appeased the general public’s call for the justice system to be tough on crime. JR would provide a viable alternative to the current problem, which would appear to be a problem with central legislation and the general short-sightedness of politics in the UK, local government require much greater micro control over released prisoners. With greater control, local authorities could look to improve certain areas that are disproportionally represented in prisons and look for those funds to help improve the affected regions. It may seem unlikely at this point, due to the scope of the project. Nonetheless, stiffer discussions in Parliament should take place. The most recent reshuffle saw David Cameron remove Kenneth Clarke and replace him with Chris Grayling. Many view this move a political move to the right. Clarke was rather too ‘liberal’ for many Tories who favour a hardline approach. Robert Winnet of The Telegraph suggests

“His [Ken Clarke] pro-European stance and relatively liberal views towards criminal justice have brought him into conflict with Mr. Cameron and other senior Tories” 

In addition, for true justice, emotion (which public opinion is mainly driven by) must be removed in order to maintain the authenticity and the impartiality of Justice. However, the nature of the political system in the UK requires politicians to be rather myopic with long-term decisions.  This emphasizes why JR could offer a viable solution for the capacity problems in the UK.

Albertson and Fox highlight the fact that public opinion appears to at least be shifting towards policies that would appear to support many of the ideas and suggestions that are presented in the Justice Reinvestment proposal.

“The public do not rank prison highly as a way of dealing with crime. Most think that offenders come out of prison worse than they go in.”

What this shows is that the public is aware of some of the immediate concerns regarding the penal system, reinforcing the need for desperate reform. By the same token however, there does appear to be a ‘stubbornness’ or lack of understanding from large sections of the public with regard to criminal justice and members still believe that sentences are too soft. The former Justice secretary Kenneth Clarke nonetheless was advocating for substantial change to the current penal system. In an interview with The Times in 2011 he not only expressed concerns over the cost of the current penal system, but also the conditions of prisons in general.

“Prisons are financially unsustainable. It is just very, very bad value for taxpayers’ money to keep banging them up and warehousing them in overcrowded prisons where most of them get toughened up.”

Whilst Clarke’s concerns regarding the aggregate cost of the prison system in the UK is justified due to the current state of the UK economy, implementation of Justice Reinvestment would require centralized power from national government being transferred to local government. This would involve “substantial transfer of funds.” (Allen and Stern 2007) The criminal system and local governments are not exempt from the public sector cuts. This outlines why JR moves funds around, rather than demand more. So it is a question of where those funds go.

Clarke’s main concerns appear to be surrounding the aggregate cost of the current penal system, it does display why the current system is simply not sustainable. JR explicitly states that local authorities will have greater micro control over how funds are utilised. In theory at least, this would present a viable alternative to the current, unsustainable system.

In part 2 I shall look into the prison population further, look at JR in more detail and arguments against JR. 

The High Price Of Low Competition.

How competition is the only way to drive prices down.

Consumer choice will always lead to lower prices. This is basic microeconomics and in competition theory the more competitive the market, the lower the prices. This unfortunately does not appear to be apparent in several markets in the UK and it is especially true in markets where demand is derived. Derived demand is basically when you demand a good or service not for its own sake, but for the goods or service derived from it. Transport is an example where customers don’t especially want to sit (or probably stand) on a train to get work because they enjoy the journey, rather, they demand this service because they know it is vital for them to get to work. It is in these markets, transport, utilities, telecommunication networks, supermarkets and the like where there is little competition and thus high prices as a result. Consumers have very little choice but to pay the competitive rate for these services due to the market structure.

The industries mentioned resemble an oligopoly, and market structure with a few firms. It has very high barriers to entry, which means it is usually very difficult for a new entrant or entrants to enter the market because there are usually very high financing costs or even legal parameters preventing new entrants. The problem with oligopolies is that because there is such little competition as a customer you end up paying more or less the same for your goods or services, so firms usually have to rely on non-price competition in order to increase their share of the market.

The global economic crisis has led to a sharp increase in the rate of unemployment and in particular in the UK. This has in turn placed a huge burden on households up and down the country and when you consider inflation is stubbornly high in recent years which reduces spending power, the price you pay for goods and services that are essential has a huge impact on your disposable income. If you look at inflation for a moment (currently 2.2%), if the rate of inflation is higher than your pay rise then your pay has not actually increased because all goods and services around you have increased in proportion, so your nominal wage may have increased, but your real wage (inflation adjusted) has not.

Now if we look at the oligopolies again, take energy for example. There are six major suppliers in the UK. They are EDF, E.ON, N Power, British Gas, Scottish Power and SSE. An important feature of this market structure is collusion. Whether it is deliberate or tacit it does not matter because if one firm reduces its prices then others are likely to follow suit because they know they are selling the same good, so there is nothing stopping a customer from going elsewhere for a cheaper price. Collusion will occur in an oligopoly regardless of the good or service. Energy firms advice customers to shop around for the best rates, the savings will be marginal at best and they only work because majority of people pay above what they actually should, so it balances out.

Five of the six major UK energy suppliers will increase their prices

Even David Cameron weighed in on the debate, exclaiming that he would “force” energy firms to offer their customers lower rates. Ofgem later published a document demonstrated that the simplification of retail energy tariffs would be complicated. Moreover, whilst his intentions may have been good, it has proved futile; customers are going to face high prices regardless.

John Kay in Financial Times last Wednesday alluded to the fact that regulation may actually hamper business activity, not aide or regulate it. Regulation is a surrogate form of competition, it can never and will never guarantee low prices or optimal consumer choice because there is nothing a regulator can do about tacit or overt collusion in a market. If the government wanted lower prices for energy they could break down some the legal barriers preventing newer entrants into the market. If for example there were ten to fifteen energy suppliers firms are likely to lower prices in order to increase market share because consumers would usually go for a firm offering the same good or service at a lower price. As it remains however, the six major firms can effectively charge what they want because they know that consumers cannot go without heat or electricity so they are forced to pay.

• SSE: 15 October, gas and electricity up 9%
• British Gas: 16 November, Gas and electricity up 6%
• Npower: 26 November, Gas up 8.8%, electricity up 9.1%
• Scottish Power: 3 December, gas and electricity up 7%
• EDF: 7 December, gas and electricity up 10.8%
• E.On: No price rise before the end of 2012

The energy sector is not the only market that has squeezed incomes and thus reduced spending power; mobile phone networks are also high on the list. There was a time in which a twelve-month contract was readily available. Again, in a market where there is such little competition the realization that you are more or less going to pay the same rate is again apparent in this market. The fact that T-Mobile and Orange have merged into Everything Everywhere makes matters worse for the consumer because it has reduced its competitiveness even more.

I personally feel that the government needs to make it far easier for new entrants to break into what appears to be closed off markets. There are legal barriers preventing new firms entering transport, so the same firms dominate the market, to the detriment of the consumer. This was the whole point of privatisation, to remove state ownership and open it up to the market, but state ownership has been replaced by private ownership and it is very much closed off. This issue is especially poignant as we see the standard of living continue to fall as a result of high inflation and sluggish economic growth. The fact that essential goods are rising accordingly only squeezes more out of the pockets of those who struggle to keep up with the price increases. Moreover, more competition ensures lower prices, regardless of regulation.