Economics, Politics

Small states and stability

…smaller states are a consequence of democracy, of peace, and of free trade. Let us hope they continue to thrive. Tim Harford

As a fan of city-states, and international jurisdictional competition, I share the sentiment. However, I worry that the piece from which it comes, while interesting, doesn’t carry the examination far enough. The important question for me is about whether this is an argument for smaller states in general, or for a system which tolerates or enables them. And what does this toleration or enabling mean? What is the exact nature of the trade that France (or the rest of the world) gets from Monaco, and what does Monaco deserve in return? Can small states exist without sponsors – either trading blocks or protective neighbours? Small states may signal a stable world, but at what proportion, and in what conditions? I have added the Jacobs book to my reading list.


John Kay is wrong: collusion is never good for consumers

John Kay, with whom I had the pleasure of working a couple of years ago, has written an article for the Financial Times (reprinted on his website) that claims sometimes, a spot of collusion can be a very good thing for consumers. He is wrong, and dangerously so.

Kay’s main claim is that competition can work ‘too well’, leading to competition for low headline rates followed by significant, invisible and unavoidable additional charges. While the undoubtedly happens in some cases, to generalise this claim is not only to assume that consumers are dolts, but also to assume that they never learn. If Kay’s ‘homily of the hire car’ teaches us anything, it’s that you need to buy only from brands you can trust not to hide their prices. If he would not make the same car hire choice again, then the business models he decries are short-sighted: they simply will not sustain in the long-run. On the other hand, if he is tempted to return to the same firm, in full knowledge of the company’s pricing practices, then he needs to consider whether there is a problem at all. (After all, I am assured that some people choose to fly on RyanAir more than once.)

Kay’s response to this – that all companies are driven to be equally conniving in a race to the bottom – is far from universally true. Price is not the only form of competition, and not all customers base their purchasing decisions on headline price alone. I am not criticising those who use comparison sites to buy things, not least because in many cases, I am one of those people. But price comparison sites are there to give the cheapest headline prices to those who care about the cheapest headline price. That makes sense in some cases, such as if you are buying a generic, well-defined product and don’t care about delivery speed or customer service. It makes very little sense when you don’t understand what you are buying.

There are businesses – good businesses – that make no attempt to offer the cheapest headline prices. Indeed some of these businesses even mock their rivals’s pricing exclusions (see the advertisement, below). Companies such as British Airways and John Lewis compete on quality and service. This doesn’t mean they abandon value (they’re Never Knowingly Undersold), it just means that they’re not tied to the idea of competing for the custom of those who want the cheapest headline price.

This British Airways advertisement mocks low cost airlines’ pricing models

Companies that compete on quality exist to serve once-bitten customers. RyanAir’s continued experiments into human psychological endurance are the best possible recruiters for quality airlines. The value of quality brands is never higher than when consumers are nervous. So there is a natural balance: some companies are bottom-feeders, others swim a little higher in the tank. When Professor Kay talks about there being no good companies left, he should consider whether looking at price-scraper websites is the best way to find them.

On the other hand, and in defence of complex pricing, there are consumers who would knowingly walk the return leg of a shuttle bus journey to get a free ride one way; enter a supermarket only to buy the loss-leaders; or hack their printer to accept liquid ink rather than buy an overpriced refill. These people are not stupid: they are benefiting from low headline prices by side-stepping the optional extras. While there are no legitimate grounds for companies to hide mandatory fees, these shady practices already attract sanction, and a good strategy for avoiding them is not to go near companies with which they are associated.

Why do I say that Kay is not only wrong, but dangerously wrong? Well, firstly, if the Professor truly believes that these businesses are verging on criminal, then why would he believe that their collusion would limit itself to creating transparent pricing standards? If these firms are not honest, then they will not become so when they meet. The relevant Adam Smith quotation is hackneyed but warrants repeating:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Adam Smith, The Wealth of Nations

Furthermore, if you start to imagine that businesses are all out to commit “petty fraud” against their customers, you start thinking that more regulation would be a jolly good idea. Not only does this introduce more red tape for all (which is likely to raises costs and prices for customers across the board) but it too quickly becomes a War on Pricing Freedom. What’s the exit strategy for such an engagement? Will any form of price discrimination be allowed? Are student discount cards to become contraband?

I hope the new Competition and Markets Authority does not undertake the “fundamental rethinking” of competition law that John Kay suggests. I can think of nothing so damaging for consumers as a government body that takes it into its head that it exists to marshall cosy cartels into price fixing agreements.  This vision is not ‘competition’. It is barely a ‘market’. It’s a call for a ‘Pricing Authority’, and that is retrograde step for us all.


Bailing in depositors

I am following the proposed depositor haircuts in Cyprus with interest. In general, I am in favour of haircutting bank creditors, including (some) depositors. It is something I pushed for when I worked for the Independent Commission on Banking. Needless to say it was considered far too radical for the UK. Which perhaps it was. However, I was glad to read this piece by Izabella Kaminska on the FT’s ever-excellent Alphaville blog, which gives a clearer exposition of my line of thinking than I could produce myself. An extract:

…I’d argue that what it really represents is the inevitable shift away from a debt funded economy to an equity funded one.

That’s not to say the shift has been managed fairly or logically. I’m with Willem Buiter on the point that it would have been better if small island depositors had been spared. But I’m also with him on the point that this is ultimately a step in the right direction.

It all comes down to the need to capitalise failing banks with equity, and to get creditors taking responsibility for their bad investments.

It’s worth reading the whole piece.


The failure of Michael Porter’s Monitor Group

Steve Denning has an interesting piece on regarding the failure of Michael Porter’s Monitor Group. He argues that Monitor encouraged clients to seek and protect niches in which they could avoid and prevent competitive challenge, rather than to innovate or to offer superior products and service.

Having never paid for the advice of Monitor Group, I cannot speak to the truth of this. However, my experience of providing consulting advice to corporate clients does not fit this pattern, and so I cannot agree with his view that this is the principle error of most consultants. There are failings in the consultancy industry, but blindly copying Michael Porter is neither the largest nor most widespread of these.

I also resist Denning’s assertion that shielding oneself from competitive challenge through the engineering of a “sustainable business advantage”  is always bad strategy in an objective sense. Denning says, “[e]xcept where generated by government regulation, sustainable competitive advantage simply doesn’t exist.” The problem is, that ‘except’ is a very big caveat. There are very few industries that I can think of, and none in which I have worked, in which regulation has not shaped the competitive landscape. Whether we like the degree of regulation that faces business today or not, businesses would be unwise if they chose not to influence it and seek benefit.

Thus the vicious circle of regulation and rent-seeking: a circle made vicious exactly because it makes sense for businesses to seek a sustainable competitive advantage rather than improve their offer, and because this in turn brings more regulation to avoid.


The world’s most expensive cities

The Economist‘s Baobab blog has a piece on the Hilton Abuja, which brings back memories of my stays there in 2005. The hotel is a not bad by West African standards. As pointed out, however, the pricing was (and apparently is still) absurd. I seem to recall that during my stay there, internet access was something like US$20 per hour, and I think I paid more to eat in their Mongolian Wok restaurant than I’ve ever paid to eat at a Michelin-starred place. Thankfully, it was on a corporate card.

Stories like this are a good reminder that if you’re looking to travel and live to Western standards, the developing world is rarely the place to do it. While there are exceptions (Thailand? Mexico? Chilé?), I remember being rather unpleasantly surprised at the price of beer and cocktails in Beijing in 2010, and apparently Angola’s capital Luanda is now the world’s priciest city. A colleague from Kazakhstan tells me that US$1m no longer buys a lot of house in Almaty.

High prices in service industries in countries where labour is cheap can represent a failure of the competitive market. This is normally induced by anti-competitive government policies, a lack of entrepreneurial spirit, and a lack of security. The market should bring the prices of the Hilton down – perhaps by improving the quality of the nearby Starwood/Sheraton, or by encouraging new alternatives – but it can’t do that if entrepreneurs can’t get the building permits, the bank loans, the skilled workforce and the stable environment they need to succeed. The next time you’re paying a fortune to stay at a mid-market hotel with views of poverty-stricken slums, blame the bureaucracy, not the business.