One reason for our inflation problem: weak merger law

Nothing excites the business section of this august organ more than news of another merger between two public companies. “Merger” is the polite word for it; usually the more accurate word is “takeover”.

So, is the dominant firm offering a good price for the firm being acquired? And should the shareholders in the dominant firm be pleased or worried about the deal? Will it benefit them, or just the company executives who organised it? A bigger company equals higher salaries and bonuses, no?

The financial press tends to regard takeovers as all good fun. Part of the thrills and spills or living and investing in a capitalist economy. But such mergers change the shape of the economy that provides us with our living. Do they make the economy better or worse?

According to the Albanese government’s Assistant Minister for Competition Dr Andrew Leigh, a former economics professor, some mergers improve the economy, whereas some worsen it.

As he explained in a speech this week, mergers are part of the market mechanism that allows financial capital to go where it’s most needed and will do most good to the consumers, workers and savers who make up an economy.

Most mergers are a healthy way for firms to achieve economies of scale and scope, and to access new resources, technology and expertise, Leigh says.

But mergers can do serious economic harm when firms are motivated by a desire to squeeze competitors out of the market and so capture a larger share of the particular market.

So “the small number of proposed mergers that raise competition concerns warrant close scrutiny” to see whether they should be allowed to proceed, he says.

The point is that, according to economic theory, the main thing ensuring ordinary people benefit from living and working in a capitalist economy is strong competition between the profit-making businesses providing our goods and services, which limits their ability to charge excessive prices and make excessive profits.

Competition obliges businesses to pass on to customers much of the savings they make from using improved technology to increase their economies of scale, while preserving the quality of service provided to their customers.

Similarly, competition between a reasonable number of alternative employers is needed to ensure their workers are fairly paid.

This is why laws controlling mergers are one of the main pillars of policy to keep competition between firms effective, along with prohibitions on the forming of cartels and other collusion between supposedly rival firms, and the misuse of “market power” – the power to keep prices above the competitive level.

Leigh says merger law is unique among those pillars because it’s the preventative medicine of competition law. While the other pillars deal with anticompetitive practices that are already being used, it deals with the likely effect of future anticompetitive actions the merger could make possible.

Fine. Trouble is, reformers have been batting for about 50 years to get effective restrictions on the ability of Australian companies to proceed with mergers designed to limit competition and enjoy excessive pricing power.

Leigh notes that a less-competitive market can add to the cost of doing business, and reduce the incentives and opportunities to invest, grow and innovate. For consumers, a less competitive market leads to higher prices, less choice, and lower growth in wages.

Big companies have resisted previous reforms – sometimes as represented by the (big) Business Council – sometimes, when Labor’s been in power, by big unions in bed with their big employers.

But now the Albanese government is making another attempt to get decent control over mergers that are expected to worsen competition.

And not before time. The challenge in Australia is to name more than a handful of industries not dominated by a few big firms.

Academic research Leigh has been associated with has shown that monopoly power worsens inequality by transferring resources from consumers to shareholders. He found evidence that market concentration – a few firms with a big share of the market – had worsened.

As well, profit margins had worsened and “monopsony hiring power” – few employers in an industry – was a problem in many industries.

After the Albanese government’s election in 2022, Treasurer Jim Chalmers and Leigh set up a Competition Taskforce within the Treasury focused on advising the government on actionable reforms to create a more dynamic and productive economy.

The taskforce’s top priority was to reform our merger laws. Consultations with industries said our piecemeal merger process was unfit for a modern economy and lagged best practice in other countries.

We were one of only three developed countries with a system of notifying proposed mergers that was merely voluntary. The Australian Competition and Consumer Commission (ACCC) complained about inadequate notification of proposed mergers, insufficient public information about the mergers, “a reactive, adversarial approach from some businesses” and limited opportunity to present evidence of likely economic harm arising from a particular merger.

In April this year, Chalmers and Leigh announced what they said were “the most significant reforms to merger rules in almost 50 years”. They would reduce three ways of reviewing merger proposals to a single, mandatory but streamlined path to approval, run by the ACCC.

For merger proposals above a monetary threshold or market-concentration threshold, this means those which would create, strengthen or entrench substantial market power will be identified and stopped. But those consistent with our national economic interest will be fast-tracked.

Challenges to the commission’s decisions will be the responsibility of an Australian Competition Tribunal, made up of a Federal Court judge, an economist and a business leader.

This should make it easier for the majority of mergers to be approved quickly, so the commission can focus on the minority that are a worry on competition grounds.

It’s the great number of our industries dominated by just a few firms that makes us especially susceptible to the inflation surge we’re still struggling to get back under control.

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The next thing on Albanese's to-do list: fix competition

In a capitalist economy, every capitalist professes to believe in stiff competition. In truth, it’s their biggest hate. Why? Because it limits their ability to put up prices and makes them work harder for their money.

Just this week, big business has been saying that, if only we could get proper tax reform – by which they mean lower taxes on companies and the highly paid – we’d get more productivity and more innovation.

In truth, what’s far more likely to improve innovation and productivity is stiffer competition, particularly in those many industries dominated by just a few giant corporations.

The federal government doesn’t have a minister for competition, but it does have an assistant minister: Dr Andrew Leigh, a former economics professor.

Last year, the Albanese government announced a rolling two-year review of competition and set up a taskforce within Treasury. It’s supported by an expert advisory panel with some big names: Dr Kerry Schott as chair, David Gonski, the former boss of the Australian Competition and Consumer Commission, Rod Sims, and the new boss of the Productivity Commission, Danielle Wood.

This week Leigh gave us an update on what the taskforce had been doing and discovering. But he started with a locker room pep talk on why competition is the key to making capitalism – or “the market system” as economists prefer to call it – benefit the customers more than the capitalists.

“Competition provides a check on unbridled profit-seeking by business. In a competitive market, innovators can bring new products and services to market, without fear of being shut down by entrenched monopolists,” he says.

Competition limits unearned privilege and seeks to treat everyone fairly. Competition guides labour and capital to their most valuable uses and combinations, driving the productivity improvement that underpins sustainable wages growth.

“For workers, genuine competition between businesses provides greater opportunities to switch jobs, allowing workers to make the most of their skills and secure better pay and conditions.”

“For consumers, competition provides more choices, allowing people to shop around and find better value products and services. Indeed, the most obvious benefit of competition is in delivering cheaper prices. There is no better tool than competition policy for keeping real prices down.”

And, Leigh adds, competition is also crucial if Australia is to make the most of the big shifts involved in digitisation, growth in the care economy and the transition to net zero carbon emissions.

But Leigh warns of “worrying signs the intensity of competition has weakened over recent decades, with evidence of increased market concentration and [profit margins] in several industries.”

“Other countries find themselves at similar crossroads and many are – like us – reviewing their competition policy settings,” he says.

Our taskforce is taking a fresh approach to competition policy: digging out and analysing large sets of data to understand what the problems are and help craft solutions to them.

The digital revolution is producing masses of “microdata” on what businesses are doing, while making it easier for statisticians to measure the growth in the economy earlier and more accurately.

It gives academic economists great ability to analyse what’s happening in particular industries, and gives the econocrats a better understanding of what and how to regulate the things business gets up to.

For the first time, the taskforce has developed a database that tracks company mergers throughout the whole economy. Believe it or not, it does this by looking at the flows of workers moving to different employers.

This will allow it to track the effects of mergers on the performance of businesses, on employment and on industry concentration – that is, fewer firms controlling more of a particular market.

The new database has already revealed three worrying things. First, because notifying the competition regulator the ACCC of an intended merger is voluntary, it hears of about 330 mergers a year, whereas there are between 1000 and 1500 mergers occurring annually.

Second, for the most part, it’s huge firms swallowing smaller firms, rather than medium and small firms joining. Get this: the largest 1 per cent of firms account for about half the acquisitions.

Larger companies made more acquisitions over the course of the 2010s. And mergers were most common in manufacturing, retail, professional services, and health and social services.

Third, the firms that are the targets of takeovers are more than twice as likely to own a patent and almost twice as likely to own a trademark.

Remember that patents give inventors a long-term legal monopoly over the use of some invention. So this finding raises the fear that at least some takeovers are motivated by a desire to gobble up an effective competitor, or may even be “killer acquisitions” aimed at killing inventions that threaten the profits of some big player.

Leigh says we can expect to hear more from the government this year on mergers and how they should be regulated. The taskforce issued a consultation paper in November asking for opinions on whether the present arrangements remain fit for purpose.

The ACCC has already proposed a significant increase in its power to block mergers considered likely to substantially lessen competition.

And, last December, the federal government secured agreement from the state treasurers to revitalise national competition policy and commit to developing an agenda for pro-competitive reforms.

Meanwhile, Leigh points to findings by British academics Geoff and Gay Meeks that reveal only one in five research papers find that the typical merger boosts the profits or the sharemarket value of the merged business.

They point out that mergers often boost the remuneration of the company’s managers, while leading to layoffs among workers.

Leigh acknowledges that mergers aren’t necessarily a bad thing, but the small number of proposed mergers that do raise competition concerns warrant close scrutiny.

He says that “for the sake of shareholders, workers and citizens, it is important to ensure that Australia’s regulatory system is not facilitating value-destroying mergers”.

Many of the nation’s chief executives may not agree with that, but most of the rest of us would.

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Our hidden inflation problem: business has too much pricing power

Why is Reserve Bank governor Dr Philip Lowe so worried about getting inflation down when so much of the rise in prices comes from foreign supply constraints that will eventually go away, and so much of the rise won’t be passed on to workers in higher wages?

Because what he can’t admit is that inflation won’t fall back to the target range of 2 to 3 per cent until the nation’s businesses decide to moderate their price rises. And they’re not likely to do that until those rises reach the point where they’re driving away customers.

It’s said that using monetary policy (higher interest rates) to control inflation is a “blunt instrument”. The only way to discourage businesses from raising their prices is to get to their customers’ wallets - by cutting real wages, increasing mortgage payments and having falling house prices make them feel less wealthy.

When explaining problems in the economy, economists use two favourite analytical tools. First, determine how much of the problem is coming from the supply (production) side of the economy, and how much from the demand (spending) side.

Second, determine whether the problem is “cyclical” or “structural”. That is, has it been caused by the temporary ups and downs of the business cycle, or by longer-lasting changes in the economy’s structure – the way it works.

I’ve argued that most of the surge in prices has come from the supply side: a horrible coincidence of supply disruptions caused by the pandemic, the Ukraine war, and even climate change.

This matters because monetary policy can do nothing to fix disruptions to supply. All it can ever do is batter down demand.

It’s true, however, that this main, supply-side problem has been worsened by the effect of strong, government-stimulated demand for goods as services.

As for the cyclical-versus-structural distinction, it’s relevant because, as Lowe never tires of reminding us, monetary policy is capable of dealing only with cyclical problems. Its role is to smooth the ups and downs in demand as the economy moves through the business cycle.

But here’s the problem: higher interest rates aren’t working to reduce inflation the way they used to because of changes in the structure of the economy.

In particular, employees and their unions now have less power to insist on wage rises sufficient to keep up with price rises than they did when last we had a big inflation problem. But big business now has more power to raise its prices.

Partly because globalisation has moved much manufacturing from the high-wage advanced economies to China and other low-wage economies, and partly because of the decentralisation and deregulation of wage-fixing and the decline in union membership, most workers pretty much have to accept whatever inadequate pay rise their chief executive (or premier) chooses to give them.

This is why all the concern about inflation expectations becoming “unanchored” is so silly. Businesses have the power to act on their expectations of higher inflation, but workers no longer do.

This is why the rate of unemployment can fall far below what economists, using data going back decades, estimate to be the NAIRU - “non-accelerating-inflation” rate of unemployment - without wage inflation accelerating.

When thinking about inflation, macroeconomists – including Lowe, I suspect - often assume our markets are competitive, and that the markets for all goods and services are equally competitive.

But as Rod Sims, former chair of the Australian Competition and Consumer Commission, and now a professor at the Australian National University, has written, markets in Australia are generally far from strongly competitive.

“Many sectors ... are dominated by just a few firms – think beer, groceries, energy and telecommunications retailing, resources, elements of the digital economy, banking and many others,” Sims says.

“This means the dominant firms have some degree of market power. That is, they can set prices at higher levels knowing competitors are unlikely to undercut them and take market share from them.

“When there is high inflation, dominant firms often realise they can increase prices above any cost rises because consumers will be more accepting of this. They will often do this subtly over time.”

In concentrated markets, firms can also easily see the effects on their few competitors, and they can watch and follow each other’s behaviour. They are confident that none will break ranks on price rises because there are benefits to be had by all.

Firms with market and pricing power are also less likely to restrain prices in response to interest rate rises, Sims says. This is because it’s not competition, but dominant-firm behaviour, that’s driving pricing decisions.

As well, market power is usually associated with reduced production capacity. How often do we see reductions in combined capacity following a merger of two competitors? When demand increases, there’s then less capacity available to serve it, so we see prices rise more than they otherwise would have.

What all this means is that it may take longer for interest rates to work to slow inflation, so patience may be needed rather than further increases. And, Sims says, there could be a role for publicly exposing high margins, to put pressure on to reduce them.

Another point he makes is that this inflation owes much to price shocks in the key, highly regulated gas and electricity industries. In these cases, the best answer is to make their regulation more anti-inflationary, not just jack up interest rates further.

The micro-economic reforms of the Hawke-Keating government have made our economy much less inflation-prone than it was in the days when inflation was last a major problem.

Meanwhile, however, we’ve allowed the pricing power of big firms to grow as successive governments of both colours have resisted pressure from people like Sims to tighten our merger law, and state governments have maximised the sale price of their electricity businesses by selling them to business interests intent on turning the national electricity market into a three-firm vertically integrated oligopoly. Well done, guys.

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Competition boss warns faith in market economy under threat

In his parting remarks last week, veteran econocrat Rod Sims, boss of the Australian Competition and Consumer Commission, offered some frank advice to his political masters and big business.

Let me put it even more frankly than he did: if governments don’t require businesses to improve their behaviour, voters and consumers could lose faith that they’re getting a fair shake from a lightly regulated economy and fall for populist solutions that make things worse for everyone.

Though business leaders make speeches in praise of competition, the truth is businesses hate competition. Why wouldn’t they? It makes their jobs much harder. To the extent the law allows, they buy out or bankrupt small competitors, and take over big ones.

In its public statements, the Business Council poses as wanting economic “reform” in the interests of us all. Behind the scenes, it lobbies governments hard to preserve big businesses’ ability to take over competitors and to impose unreasonable terms in transactions with small businesses.

Politicians make speeches about the importance of small business because all those owners add up to many votes. But pollies yield to the lobbying of big businesses because they make generous donations to party coffers, which can be used to buy votes through advertising and the rest.

It follows that the competition commission and whoever’s running it get a hard time from business interests. The more effective that person is in seeking to achieve “effective competition”, the more criticism they attract.

Whenever they take court proceedings that fail, there’s much crowing by business commentators. Elsewhere, competition regulators are attacked for being sleepy and toothless watchdogs.

Of course, public servants are too discrete to say all that. So let’s switch to what Sims actually said in his valedictory speech to the National Press Club. It was frank - by the standards of econocrats.

“When I arrived at the commission [11 years ago] I mentioned my main objective in chairing the commission was ‘that Australians see that a market economy and strong competition work for them and that they see the commission working tirelessly for the long-run interests of consumers’, he said.

“We must recognise that a market-based economy is fragile, as its organising principle relies on companies and businesspeople pursuing their own self-interest. This is not an obvious way to organise things.

“For this to work to the benefit of all Australians requires, at a minimum, strong competition between firms and strong enforcement of the Competition and Consumer Act.

“In our society, large established businesses have a strong voice, which is not surprising as the largest firms employ many people and supply Australians with many of their needs.

“Often, however, the understandable interest of large established businesses in short-term advantage sees them, I believe, work to the disadvantage of their own long-term interests,” he said.

Large established businesses had opposed all the main changes to the competition Act when they were introduced, he said. For example, laws against misleading and deceptive conduct.

“I would ask, however, how many specific interventions and extra red tape would we now have that would damage our market economy, if we did not have this general provision?”

The competition Act largely had economy-wide laws, whose effectiveness underpinned the necessary wide acceptance of the market economy. “Perceptions of unfairness and inequity will see faith in a market economy eroded,” he warned.

Last year Sims proposed a tightening of our merger law. Big business was loud in its disapproval. Distinguished corporate lawyers insisted the present laws were working fine. Business commentators were dismissive.

Last week Sims said “large established businesses and their advisers will oppose these changes, but my guess is that well over 90 per cent of Australians would support them. Further, I think such changes would strengthen our market economy, and would benefit the vast majority of Australian businesses.” (He means the smaller ones.)

When Sims took over the commission in 2011, it had a near-perfect success rate in its court actions. He took this as a sign it was being too cautious in its efforts to enforce the law.

Eleven years later, “we have a good win/loss record, including recent guilty pleas in cartel cases, including by individuals in two criminal cases. I recognise, however, that we have had some losses, including in a recent high-profile case.”

The commission’s record on enforcing the protection of consumers “includes creative wins against companies such as Trivago (where we unpicked its algorithm) and Google, and we have seen penalties imposed by the courts for breaches of the Act increase from $1 million being seen as high, to recent penalties of $50 million against Telstra, $125 million against VW, and $153 million against AIPE, a vocational education provider.”

Let’s hope Sims’ successor is just as diligent in protecting the market economy against its own excesses.

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Reduced competition between businesses is harming productivity

In the search for explanations of the slowdown in productivity improvement, the world’s economists are closing in on one of the significant causes: reduced competition between the businesses in an industry, giving them increased “market power” – ability to raise the prices they charge.

Research by various Treasury economists has found evidence of this happening in Australia. And this month US President Joe Biden acted to increase competition in various markets where it had been lacking.

A new study by Jonathan Hambur has added to earlier research by Treasury people finding that Australia’s private sector has shown less “dynamism” – ability to become more economically efficient over time – during the past decade or so.

Hambur has used a database of tax returns covering almost all Australian businesses to find that their “mark-ups” have increased by about 5 per cent since the mid-noughties.

To economists, a firm’s mark-up is the ratio of the prices it charges compared to its “marginal” cost of production – that is, the cost of the last unit it produced.

Hambur says that, while part of this increase seems to have been caused by technological change, it also shows an increase in firms’ market power and a decline in competition.

If so, this would explain about a fifth of the slowdown in the rate of productivity improvement we’ve seen over the past decade, since we already know the same period has seen slower reallocation of resources from low-productivity to high-productivity firms.

We measure productivity by comparing the quantity of the output of goods or services with the quantity of inputs of raw materials, labour and physical capital used to produce the output. Increasing output per unit of input is the main way we’ve been able to keep improving our material standard of living over the past two centuries.

And one of the ways an economy increases its productivity is by more of the production being done by the firms that are best at turning inputs into outputs at the expense of the less-efficient firms. Resources (inputs) are thereby “reallocated” to their most efficient use. What causes this reallocation to occur? Price competition between the firms in an industry.

Many people assume big companies can set whatever price they like. But this can’t be true. Even in the case of a single firm selling an important product, if the monopolist uses its considerable market power to set a price that’s simply too high for many people to afford, it will get to a point where it loses more from the sales it no longer makes than it gains from the extra profit it makes from those people still willing and able to pay the extra.

This is why economists say a firm wanting to maximise its profits is able to charge no more than “what the market will bear”. How much the market will bear depends mainly on the strength of the competition it faces from other firms selling the same product.

The textbook, neo-classical model of a “perfectly competitive” market – which is hugely oversimplified and has never existed in the real world – tells us the many firms in a market are able to charge a price no higher than their marginal cost of production (remembering that the “cost” includes a rate of profit just sufficient to discourage the owners of the firm from taking their financial capital to another market).

In this case, each firm that survives in the market will be able to charge only the identical market price set by the marginal cost. A firm that tries to charge more than the market price will sell nothing, whereas a firm that charges less will sell out immediately, but then go out backwards because it hasn’t covered its costs.

In the real world, there are a host of possible reasons why firms are able to charge a price higher than their marginal cost, and so make excess profit: because customers don’t know where to find the products that are cheaper but just as good, because customers are bamboozled by advertising and phoney “product differentiation”, because economies of scale and improved technology allow firms to get bigger and reduce their average cost of production.

Firms pursue scale economies and other innovations in the hope of making excess profits, but theory tells us that competition from other firms will end up forcing them to pass their cost savings on to their customers in the form of lower prices. The consumers always beat the capitalists.

When competition isn’t strong enough to make this happen, however, firms can and do earn mark-ups well above their marginal costs. Now Hambur has confirmed this happens in Australia. Worse, our mark-ups have increased over the past decade, telling us competition has weakened further and given our businesses greater market power.

With US economists finding similar evidence of reduced competition contributing to America’s own productivity slowdown, it’s not surprising to see President Biden acting to increase competition. Earlier this month he signed an executive order urging federal government agencies to crack down on anti-competitive practices ranging from agriculture to pharmaceuticals.

He denounced the present era of business monopolies. “Rather than competing for consumers [businesses] are consuming their competitors; rather than competing for workers they are finding ways to gain the upper hand on labour,” he said.

“Let me be very clear, capitalism without competition isn’t capitalism, it’s exploitation.”

Biden directed the Department of Justice and Federal Trade Commission to carefully review mergers and even challenge deals already put through.

He directed the trade commission to deal with competition concerns about the behaviour of Facebook, Apple, Alphabet’s Google, and Amazon, and to limit “killer acquisitions” where large internet platforms buy out potential competitors.

The justice department will launch a review of merger guidelines to determine whether they are “overly permissive”.

So, what could our government do about our own decline in competition? Well, we could start by tightening our own merger laws so the Australian Competition and Consumer Commission can be more successful in its efforts to protect us from anti-competitive takeovers.

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