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Competition policy evaluated

By Saul Eslake - posted Wednesday, 7 December 2005


My intellectual starting point when talking about competition is almost, to paraphrase the fictional character Gordon Gecko (played by Michael Douglas) in Oliver Stone’s 1987 film Wall Street, “Competition is good. Competition works; competition is right. Competition clarifies, cuts through, and captures the essence of the evolutionary spirit. Competition in all its forms … has marked the upward surge of mankind … and competition, mark my words, has saved the previously malfunctioning corporation called Australia”.

I said my intellectual starting point was almost that paraphrase, because I would want to qualify it by noting that competition is not an end in itself, but rather a means to an end, and that, as the Productivity Commission’s chairman Gary Banks has pointed out, “there are circumstances in which restraints on competition can be justified from a community-wide perspective”.

Nonetheless, at least since Adam Smith pointed out nearly 230 years ago that “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices,” most economists have recognised the importance of having and enforcing competition laws.

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And research over the past decade supports the proposition that productivity growth is enhanced by competition.

Summarising this research, a 2002 paper from the OECD concludes that “competition has pervasive and long-lasting effects on economic performance by affecting economic actors’ incentive structure, by encouraging their innovative activities, and by selecting more efficient ones from less efficient ones over time”. It goes on to show that “the link between product market competition and productivity growth is positive and robust”.

Australia’s experience exemplifies the conclusions of this research. The principal purpose of most of the “micro-economic reforms” of the past two decades has been to expose businesses, workers and government instrumentalities to greater competition, both from abroad (through, for example, reductions in barriers to imports and to foreign investment) and from within (through, for example, de-regulation, privatisation and competition policy).

The result has been a significant improvement in Australia’s productivity performance, relative both to our own (rather unimpressive) history, and relative to other countries at comparable stages of economic development.

Australia’s labour productivity growth rate accelerated to 2.8 per cent a year over the decade ended 2003-04, from an average of 2.2 per cent a year over the preceding three decades. That might not sound a lot, but it means that it takes 26 years to double our output per hour worked at the growth rate of the past decade, compared with 33 years at the growth rate of the preceding 30 years.

Our multi-factor productivity growth rate - which measures the efficiency with which labour and capital are combined to produce output - improved from an average of 1.1 per cent per annum over the three decades ended 1993-94 to 1.5 per cent per annum over the ten years ended 2003-04 - enough to cut the time required to double our output per unit of labour and capital inputs by 17 years.

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Australia is one of a handful of OECD countries which have been able to reverse the substantial decline in productivity growth which set in after the first oil shock of the 1970s.

Partly as a result, Australia has also been one of the few Western countries in which growth in per capita GDP - the broadest commonly available measure of improvements in average living standards - has trended upwards since the 1980s.

Enhanced domestic and international competition within Australian product and labour markets has contributed to this result, not only by the impact it has had on boosting productivity growth, but also by enabling the economy to operate at higher rates of resource utilisation (that is, at lower rates of unemployment, among other things), without generating the sort of cost and price pressures which in previous cycles would have prompted the Reserve Bank to curtail the economic expansion through aggressive increases in interest rates.

This argument is supported by some recently-published work by Reserve Bank researchers, which finds that less product market regulation has played a role in reducing the volatility of aggregate output, even after controlling for other factors such as a decline in the magnitude of global economic shocks, and changes in monetary policy regimes.

Competition has provided an additional source of discipline on the capacity of firms to raise prices, and of labour to extract wage increases over and above improvements in productivity, in the face of increased demand and tighter supply.

Despite the significant benefits for the Australian economy and for Australian consumers of the greater role played by competition in the Australian economy over the past two decades, Australians retain a curiously ambivalent attitude towards competition.

As in so many aspects of Australian life and culture, Australians tend to apply different standards to sport from those which they apply in other areas. Australians seem to regard competition - albeit within well-defined and (usually) strictly-enforced rules - as something to be applauded on the football field, the running track, the cricket pitch, the swimming pool and the tennis court, but see it as something to be regarded elsewhere with a mixture of fear and loathing.

Australians readily acknowledge that competition is a spur to greater achievement in sport. But a surprisingly large number of them seem still to regard international competition in other areas as something from which governments should shelter them (or their employers).

And it’s still far from uncommon to hear or read of business people and or their representatives objecting to Sunday trading, the removal of laws restricting entry into particular industries, or calling for legislation preserving their share of particular markets.

The OECD’s annual survey of the Australian economy pointed out earlier this year, there is still more work to be done to “promote higher growth by further strengthening competitive pressures in the economy”.

Australia still ranks only 16th among OECD countries in terms of GDP per hour worked, 19 per cent below the comparable figure for the United States. On this measure, Australia’s aggregate labour productivity has fallen from 86 per cent to 81 per cent of the US level, and from 95 per cent to 92 per cent of the average OECD level, since 1998.

There may be reasons stemming from our geography, scale and distance from other major economic centres as to why we cannot aspire to close the gap entirely; but there can be little doubt that there is still considerable potential to improve Australians’ standard of living through further pro-competitive and productivity-enhancing reforms.

The latest annual national accounts show that Australian labour productivity actually fell by 1.3 per cent in the 2004-05 financial year, the first decline since 1986-87 and the third largest decline in the 39 years for which such data is available. This decline in labour productivity was broadly-based, falling in 11 of the 14 market sectors for which such data is compiled - the first time in 18 years when a majority of industries have registered negative productivity growth.

This somewhat unexpected decline in labour productivity may be partly - but only partly - due to the traditional lag between a slowdown in the rate of economic growth (which began in 2004) and the corresponding slowdown in employment (which has begun only quite recently).

The ABS has previously attributed it to a combination of the significant improvement in profitability arising from the strong increase in Australia’s terms of trade (the ratio of export to import prices) in recent years, which may have made employers less likely to shed labour in the face of a slowdown in output growth.

But that doesn’t explain why multi-factor productivity also declined by 1.7 per cent in 2004-05, the largest decline in 22 years. This decline in productivity adds further gravitas to calls for a re-invigoration and extension of the reform agenda.

The Federal Government argues that it is doing that with its proposed workplace relations reforms, and to a large extent I agree with that: although it’s important to note that, to the extent that such reforms are successful in getting people with low skills into employment (as was with New Zealand’s 1990s labour market reforms), aggregate productivity will initially decline.

Although the level of product market regulation in Australia is now quite low by OECD standards - only Ireland and Britain have lower levels, on average - there is still ample scope for further reform.

Electricity, gas, water, transport and communications stand out as areas where further reforms would yield large dividends, as has been well-documented elsewhere.

There is also unfinished business in regard to enhancing competition in retailing, From that perspective, it is disappointing that the Federal Government has recently flinched at the opportunity to introduce greater competition into the retail pharmacy sector.

It is similarly disappointing that Western Australians voted down a referendum proposing the removal of restrictions on shopping hours - and little short of astonishing that they did so at the urging of that state’s ostensibly “pro-free enterprise” Liberal Party. As the National Competition Council pointed out, “the evidence is that such restrictions are not in the public interest”. Moreover, while it is easy for opponents of unrestricted shopping hours to mount “fear campaigns” in communities which have no experience other than of governments telling them when they can shop, or with whom, experience in places such as Bendigo and Canberra suggests that once consumers do have the opportunity to experience deregulated trading hours, they are much more inclined to resist efforts to bring back the dark ages.

There is also plenty of scope for the extension of competition in areas serviced by professions such as medicine, the law and architecture. Once again the OECD is emphatic on this score: “there is little empirical evidence … to suggest that regulatory interventions in the area of professional services that prevent competition improve consumer welfare. In practice, these restrictions have been associated with higher prices and weaker innovative activity without significant quality improvements, serving mainly the interest of the profession”.

Finally, while National Competition Policy has primarily focused on areas of state jurisdiction, its impact on federal government practice has been more limited. The National Competition Council’s 2003 assessment of governments’ performance in implementing NCP noted that there were five areas in particular where the Federal Government had not met its obligations - wheat marketing, broadcasting, the Australia Post monopoly on standard letter services, the monopoly on provision of superannuation services to MPs and restrictions on the import of second-hand motor vehicles.

However it is wrong to imagine that the task of promoting and strengthening competition is achieved only through de-regulation.

As the economy becomes less regulated in the traditional sense of that term, as government-owned instrumentalities cease to exist or become less important, and as globalisation puts more activities actually or potentially beyond the reach of national governments and regulatory agencies, the importance of competition as a discipline on business behaviour increases - and with it the importance of effective enforcement of competition laws.

Thus, for example, I think it’s entirely proper that the Federal Government is seeking to take a tougher legislative approach towards anti-competitive cartels and to prescribe tougher penalties for breaches of laws pertaining to cartel behaviour.

Similarly I think the ACCC should take a tough line, unless persuaded to the contrary, in relation to mergers which appear, at least on the surface, to result in a substantial lessening of competition. I’m happy to leave precise definitions of what that means to the lawyers.

All of which serves to bring me back to the point that competition is not an end in itself, but rather is desirable only to the extent that it furthers the welfare of the Australian people.

As ACCC chairman Graeme Samuel said earlier this year, “a society that relies purely on market forces to distribute the benefits of change will inevitably sow the seeds for polarisation and resentment. Ultimately, this feeds into social dislocation and political instability”.

Advocates of greater competition thus need to be careful that their advocacy identifies the benefits which greater competition will bring to consumers, rather than merely to producers or sectional interests; that their advocacy does not amount to a plea for deregulation for deregulation’s sake; and that their advocacy also includes advocacy of the need to assist those adversely affected by the extension of competition to cope with the resulting changes.

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This is an edited version of a speech given to a conference on Government Competition Policy and Economic Reform in Sydney on November 29, 2005 . The full text can be found here (pdf file 96KB).



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About the Author

Saul Eslake is a Vice-Chancellor’s Fellow at the University of Tasmania.

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