Puzzling over the rich economies' poor productivity improvement and weak wage growth (but healthy profits), American economists are pointing the finger at reduced competition between firms. But can this explain Australia's similar story?
Jim Minifie, of the Grattan Institute, set out to answer this in his report, Competition in Australia.
Economists regard strong competition between businesses as essential to ensuring market economies function well, to the benefit of consumers and workers.
Competition is what economic theory says stops us being ripped off by the capitalists. Firms that overcharge for their products lose business to firms that undercut them.
So competition pushes prices down towards costs (which economists – but not accountants – define as including the "cost of capital", or "normal profit", the minimum rate of profit needed to induce firms to stay in the market).
Competition helps ensure that economic resources - land, labour and (physical) capital – move to the uses most valued by consumers.
Competition also encourages firms to come up with new or better products – or less costly ways of producing a product – in the hope of higher profits. But those that succeed in this soon find their competitors copying their ideas, and bidding down the price to get a bigger slice of the action.
The innovations improve the economy's productivity (output per unit of input), but competition soon takes away the higher profits, delivering them into the hands of consumers, who often get better products for lower prices.
That's the theory. Question is, to what extent does it hold in practice? And does it hold less in recent years than it used to?
The simple theory assumes any market has a large number of sellers, each too small to be able to influence the market price. In practice, however, many of our markets are dominated by two, three or four big firms.
Why? Mainly because of the presence of economies of scale. It's very common that the more you produce of something – up to a point – the less each unit costs.
So, it makes great sense to have a small number of big firms doing much of the production – provided competition ensures most of the cost saving is passed on to customers in lower prices. Which, as a general rule, it has been over the decades.
Trouble is, big firms do have some degree of control over prices. And it's common for the few big firms in an industry to come to an unspoken agreement to compete using advertising or product differentiation, but not price.
Firms can increase their pricing power by taking over their competitors to get a bigger share of the market. It's the role of "competition policy" – run in our case by the Australian Competition and Consumer Commission – to prevent overt collusion between firms, and takeovers intended to increase market power. But how well is that working?
"Natural monopolies" – where it simply wouldn't make economic sense for more than one firm to serve a particular market, such as rival sets of power lines running down a street, or two service stations in a small town - are another common departure from the theoretical model.
So, what did Minifie find in his study of competition in practice? He found evidence it had lessened in the United States, but not here.
He found plenty of markets where a few firms did most of the business. But "the market shares of large firms in concentrated sectors are not much higher in Australia than in other countries [of comparable size], and they have not grown much lately," he says.
Nor have their revenues (sales) grown faster than gross domestic product. The profitability of firms – profits relative to funds invested - hasn't risen much since 2000.
Minifie identifies eight industries characterised by natural monopoly (in descending order of size): electricity transmission and distribution, wired telecom, rail freight, airports, toll roads, water transport terminals, ports and pipelines.
Then there are nine industries where large economies of scale mean they're dominated by a few firms: supermarkets, wireless telecom, domestic airlines, then (of roughly equal size) internet service providers, pathology services, newspapers, petrol retailing, liquor retailing and diagnostic imaging.
Next are eight industries subject to heavy regulation by government: banks, residential aged care, general insurance, life insurance, taxis, pharmacies, health insurance and casinos.
(Often, these industries are heavily regulated for sound public policy reasons, but the regulation often acts as a barrier to new firms entering the market, thus allowing them to be dominated by a few firms.)
But note this: by Minifie's calculations, natural monopolies account for only about 3 per cent of "gross value added" (a variant of GDP), while high scale-economies industries account for 5 per cent and heavily regulated industries for 7 per cent.
So that means the parts of the economy where "barriers to entry" limit competitive pressure make up about 15 per cent of the economy. Then there are 29 industries with low barriers to entry making up the rest of the "non-tradables" private sector, and about half the whole economy.
That leaves the tradables sector (export and import-competing industries) accounting for 14 per cent of the economy and the public sector making up the last 20 per cent.
Even so, Minifie confirms that, in industries dominated by a few firms, many firms make "super-normal" profits – those in excess of what's needed to keep them in the industry.
By his estimates, up to half the total profits in the supermarket industry are super-normal. In banking it's about 17 per cent.
Other companies and sectors with substantial super profits include Telstra, some big-city airports, liquor retailers, internet service providers, sports betting agencies and private health insurers.
Comparing this last list with the lists of natural monopolies and heavily regulated industries suggests governments could be doing a much better job of ensuring the regulators haven't been captured by the companies being regulated.
