The world is a complicated place. I have no doubt that the capitalist, market-based way of running an economy delivers the best results for workers and consumers. But that doesn’t mean companies never do bad things, nor that every business always does the right thing by its customers.
The father of modern economics, Adam Smith, famously said that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.
But, he argued, the “invisible hand” of “market forces” – the interaction of demand and supply in moving prices up and down – takes all the self-interest of businesses and the self-interest of consumers and turns them into businesses getting adequately rewarded for delivering just the right combination of goods and services to all the people in the economy.
There’s a huge amount of truth to that simple – if hard to believe – proposition. But it’s not the whole truth. One way to think of it is that, as Winston Churchill said of democracy, it’s the worst way of doing it – except for all the other ways. In this case, except for leaving all the decisions about what and how much to produce to the government.
So, to say capitalism is the best way of organising an economy isn’t to say it’s without fault. That it never does things badly.
In a speech this week, Rod Sims, the former chairman of the Australian Competition and Consumer Commission, but now a professor at the Australian National University, said that although companies regularly proclaim that they put their customers first, “companies clearly do not always have the interests of their customers in mind”.
So what are the reasons that, almost 250 years after Smith’s discovery, capitalism doesn’t always give consumers a good deal.
Sims can think of six reasons market forces don’t live up to their billing.
For a start, meeting customer needs may not be the main way companies increase their profits. Businesses are motivated to make profits and to increase those profits. But being the best at meeting the needs of customers isn’t the only way, or even the dominant way, firms succeed, Sims says.
For a firm to stay ahead of its rivals by continually improving its products and services is difficult. And eventually another firm works out how to do things better and cheaper than you.
“Commercial strategy therefore is largely about building defences against the forces of competition. To make it more difficult for other firms to develop a better product. Or, if they do, to limit their access to customers,” he says.
Another reason is that company executives are under considerable sharemarket pressure to increase short-term profits. Companies strive to grow because this attracts investors, the value of their shares rises and their top executives get bigger bonuses.
Sims says many companies set high growth targets to meet the expectations of the sharemarket. Often these targets are higher than the economy’s growth, meaning not all firms can meet or exceed market expectations.
So, in some cases, company executives see no alternative but to push the boundaries to achieve the targets they’ve been set.
That’s bad, but it becomes worse if the poor behaviour of a few causes normal competitive pressure to keep getting better than the others to reverse and become a race to the bottom.
Sims says that in well-functioning markets firms compete on their merits. Firms that offer what consumers value, displace firms that don’t. But the opposite can occur if poor behaviour goes undetected and unpunished, so it gives bad players a competitive edge.
“Firms can win customers through misrepresenting their offers and employing high-pressure selling tactics,” he says. As well as hurting consumers, such behaviour hurts rival firms, tempting them to protect their market share by employing the same questionable tactics.
Yet another problem occurs when firms see nothing wrong with what they’re doing, but their customers do. They (and economists) see nothing wrong with offering a better price – or interest rate – to new customers than they’re charging their existing customers.
But those older customers commonly react with outrage when they discover they’ve gone for years paying more than they needed to. They feel their loyalty has been abused.
Speaking of loyalty, Sims’ final explanation of why customers may be treated badly is that executives may feel their obligations to their company compel them to pursue profit to the maximum, even if their behaviour pushes too close to the boundaries of the law and isn’t the behaviour they would engage in privately.
So, what should be done about all these instances of “market failure” – where markets don’t deliver the wonderful benefits advertised by economists?
Sims has two remedies. First, as he argued strongly while boss of the competition and consumer commission, it needs stronger merger laws to help it prevent anti-competitive mergers. The courts require evidence about what will happen after a merger has occurred, but it’s hard for the commission to prove what hasn’t yet happened.
“The courts seem largely unwilling to accept commercial logic; that if you have market power you will use it. The courts can sometimes seem naive,” he says.
Second, we need a law against unfair practices, as they have in the United States, Britain and most of Europe.
“Our current laws are poorly suited to stopping behaviour ranging from online manipulation of consumers, to processors saying they will reject farm goods unless the prices agreed before the goods were shipped are now lowered.”
In the end, it’s simple. All the claims that capitalism will deliver a great deal for consumers are based on the assumption that businesses face stiff competition from other businesses to keep them in line.
But when too many markets are dominated by a few huge companies, service goes down and prices go up by more than they should.