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Renegade Economists Show 579

As broadcast on the 3CR airwaves 6 – 6.30pm on the fourth Wednesday of the month.

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Show Notes
This is episode 6 of the Georgist Podcourse. Both natural resource rents and natural monopolies increase in value with little effort from the owner. Despite this, our economic policy barely recognises these natural advantages. We delve into the regulatory pressures the government faces as various interest groups are favoured over others. Below is another reminder to read more Hansard. Let’s hope regulators use more ‘natural monopoly’ tests instead of ‘private profitability’ tests.

Related Links

Rex Patrick’s oil & gas inquiry. Please submit!

Discussion on the regulation of gas pipelines, Michael Vertigan, AC.

Gas pipelines tend to have natural monopoly characteristics derived from the following three factors: investments in pipelines are indivisible; economies of scale exist, and; sunk costs are large. The natural monopoly characteristics of gas pipelines can create a high barrier to entry for prospective competitors to an existing pipeline, which in turn tends to enhance the market power of existing gas pipeline operators.

Internal analysis carried out by one pipeline operator indicated that it is earning 70 per cent more revenue than it would if it was subject to full regulation.

Various shippers in eastern Australia indicated that they are hesitant to publicly challenge the prevailing prices for pipeline services, concerned that incumbent pipeline owners could ‘retaliate’ when their existing arrangements came up for renewal.

Central Petroleum, a gas producer looking to transport gas from the Northern Territory to eastern Australia, has been quite vocal in its belief that pipeline operators are exercising their market power by monopoly pricing.
‘the incumbent pipeline owner is incentivised to set tariffs at a level just below the higher new entrant alternative. As a result, the cost efficiencies that are inherent to existing pipeline assets are not shared with the markets upstream or downstream of that pipeline creating market inefficiencies and muted pricing signals to gas suppliers and customers’.

Since the Liberal-National Government outlined new measures to protect Australia’s domestic gas supplies in early 2017, the spot price of gas in eastern Australia has fallen by more than 25 per cent and gas contract offers have fallen by up to 50 per cent.

… The amendment is intended to refocus the test to a ‘natural monopoly’ test instead of a ‘private profitability’ test.

Notes from the Economic Standing Committee, Australian Competition and Consumer Commission annual report 2018, on the role of natural monopolies:

Andrew Leigh, Shadow Assistant Minister for Treasury: How concerned are you that the problems of excessive oligopoly power in the Australian economy are bad and potentially getting worse?

Mr Rod Sims, Chairman of the Australian Competition and Consumer Commission: I think there’s definitely a problem. Given your background, I might just put things this way, that famous Solow growth model says that the rate of growth and the economy is a function of labour, capital and productivity. I certainly have some discussions with economists who say you could have a negative sign there for the economic rents generated from excess monopolies. So I think the economic rents from concentrated behaviour area problem. I think it is a drag on the economy. Is it getting worse? I don’t know.

The key issue we have in relation to all of that is,I guess, whether our merger regime is working appropriately to deal with that, because the best way to deal with it is to stop mergers happening in the first place. We have tried and failed to stop mergers in the electricity area, transport and supermarkets. And we are in court at the moment, which limits what I can say in relation to four going to three in mobile phones, which is a crucial area.

There is a lot that we are trying to there, but we do have trouble convincing the courts of the problems associated with increasingly concentrated industries.

Dr LEIGH: Are you therefore arguing for a change in the substantial-lessening-of-competition test or a change in your information-gathering powers and your ability to enforce the existing laws?

Mr Sims:That’s a good question. We are still working our way through that. The complexity is as follows. You would think that a test that says ‘likely to substantially lessen competition’ would do it, keeping the emphasis on the words ‘likely to substantially lessen competition’. I guess what we are finding is that the Australian environment, which manifests itself through the courts—but I think it is a general issue and the courts are a mechanism through which that gets transmitted—doesn’t seem to have the same concerns about concentrated markets as we do. Of course you can have some markets where having three players is fine, but for most markets where there are not really heavy fixed costs you really need more players than that. We think, therefore, that there should be some presumption that there is a problem unless someone can explain why there isn’t. Yet we seem to struggle to convince the courts that there are these problems.I guess there is also this view that it’s better to have three or four big players who look alike, whereas our view is that having players that approach the market in different ways is better. We have got four big banks, which have about 70 to 75 per cent of the market, and they are not competing on price because they look similar. If we had different players at different stages of development with different models—as I say, it is before the courts, but that is our issue in the mobile market: we have four players potentially going to three. So we are just trying to begin a discussion. I think it’s good that it is a community discussion. How concentrated do we want the market to be? How much do we want to presume that concentration causes problems? I understand the economic arguments that say it doesn’t always, but the economic arguments actually say that most of the time it does, so why don’t we start with that? We are still thinking it through. It is a complex issue, as you know just as well as I do.
….
Mr Sims:Thank you. I knew you’d help me out. At the moment the airports aren’t regulated. They are monopolies. We do have a general concern about monopolies not being regulated. We’ve got that issue at the moment also with the Port of Newcastle, which is a straight-out monopoly. So that issue is on foot as well. With the airports, where you’ve got large-scale users, business users—we’re not talking about dealing with individuals—what we thought was appropriate was a fairly light handed form of regulation, which would be a negotiate-arbitrate model. It’s very hard to negotiate with a monopoly, but if you’ve got the ability to go to arbitration, which of course is a messy process that no-one wants to do, it can even up the bargaining power. We had in mind a commercial arbitration, so it wasn’t trying to create extra work for us, much like the gas pipeline new regime that was brought in by the government. We have proposed a commercial negotiate-arbitrate, and I think that’s what the airlines are supporting. I could be wrong, but I think that’s the gist of what they’re supporting.

CHAIR: Can I seek clarification? Is there another sector—you just mentioned one in gas pipelines—where other equivalents of this model that you’re proposing are effective?

Mr Sims: The only one I can think of is gas pipelines. That’s for commercial negotiate-arbitrate.

Mr Cosgrave: For a commercial negotiate-arbitrate model that’s right. There are and have been in the past various models of negotiate-arbitrate where the arbitration is conducted by a regulator. There was such a model in communications for many years. It’s been considered in some other sectors as well.

CHAIR: Obviously the PC has done a report in this space. What are your reflections on their analysis?

Mr Sims: The PC probably has a different philosophical view. We chat to the PC quite a lot. We’ve got a good relationship with them. They are super-smart economists, there is absolutely no doubt about that. I guess we are a bit more in the camp of regulating monopolies unless there is a very good reason to do it. I think their approach is, ‘Show me how they have misbehaved as monopolies before I regulate them.’ That’s often very tricky to do. If you take a port, for example, or any monopoly asset, they could be increasing their charges by five or six per cent a year, which is probably double the rate of inflation. They could do that over a long time and have a very comfortable existence. They could make a lot of money. They might not be as productive, going back to Dr Leigh’s question. So I think that is the difference between us and the PC. It’s more of a philosophical starting point than anything else.

CHAIR: You’re looking through the lens of competition, and they’re looking at it mostly through efficiency?

Mr Sims: No. They would probably characterise us as being a regulator so we like regulation. I understand that. They come from the point of view of saying, ‘Don’t regulate unless you absolutely have to.’ I’m being simplistic about both camps. Our view is that regulating monopolies can improve efficiency because you can put various incentive mechanisms in the regulation. That can keep them more on their toes than if they are not regulated at all.
….
Mr BANDT: This is in part because of data that’s publicly available and in part because of reports that you’ve produced. For example, on 4 September, there were periods of dropping into negative pricing. With negative pricing, you would expect that’s because there’s too much electricity being provided—more than is needed—and most reasonable people might expect that then some generators would wind back the amount of electricity that they’re putting into the grid. But there’s evidence that coal-fired power generators have been increasing the amount that they’ve been putting into the grid during these periods of negative pricing. You might expect that’s an ideal time for pumped hydro storage—for example, Wivenhoe—to start switching on because they’re going to be able to make money from storing electricity while they are not pumping, and they just happen to be owned by one of these dominant market players that has heavy investment in fossil fuels. Is that an indication of the market working well—that coal-fired power ramps up at a time when prices are negative and pushes out solar, which is what has been happening?

Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries

MR O’DONOVAN: All right. But – so you wouldn’t accept that that one per cent improvement in your EBIT percentage represents in any way Metcash taking a bigger margin?

MR REITZER: It does represent Metcash taking a bigger margin because, if you look at the overall profitability in the industry in the year 2000, and if you specifically look at my competitor that sets that profitability, Woolworths determine how much profit there is on the table for the independent retailers and Metcash to share. And back in the year 2000 –and that’s the competitive tension that I referred to that gets created at retail – so back in 2000 I can’t remember what EBIT Woolworths were operating at in their grocery, but I think it was half of what it is now as well. And that was the profit pool, if you want, that was available for the independent retailers and Metcash to share. Now it’s doubled.

MR O’DONOVAN: All right. So you have effectively followed your – your network has followed Woolworths up …

MR REITZER: Yes.

The need for regulation is paramount. Once markets seem to fall under five major competitors, oligopolistic practices ensue. The taxation of such markets has not been perfected. More work needed.

Check the previous podcourse shows, designed for those wanting to understand the basics of Georgism.

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Georgist Glossary

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Julian Hochgesang