Author: Catherine Youds

Inflation has surged worldwide as countries have come out of their COVID-19 lockdowns. The increases in prices combined with supply-chain problems has raised questions of what will happen to future prices and whether it will feed further inflation cycles.

Inflation targeting

Inflation is a key contributor to instability in an economy. It measures the rate of increases in prices over a given period of time and indicates what will happen to the cost of living for households. Because of its importance, many central banks aim to keep inflation low and steady by setting a target. The Bank of England, the Federal Reserve, and the European Central Bank all aim to keep inflation low at a target rate of 2 per cent.

Inflation-rate targeting has been successfully practised in a growing number of countries over the past few decades. However, measures to combat rising inflation typically contract the economy through reducing real aggregate demand (or at least its rate of growth). This is a concern when the economy is not experiencing a strong economic performance.

Current outlook

Globally, rising inflation is causing concern as a surge in demand has been confronted by supply bottlenecks and rising prices of energy and raw materials. As the world emerges from the COVID-19 lockdowns, global financial markets have been affected in recent months by concerns around inflation. They have also been affected by the prospect of major central banks around the world being forced into the early removal of pandemic support measures, such as quantitative easing, before the economic recovery from the coronavirus is complete.

The Chief Economist at the Bank of England has warned that UK inflation is likely to rise ‘close to or even slightly above 5 per cent’ early next year, as he said the central bank would have a ‘live’ decision on whether to raise interest rates at its November meeting. Although consumer price inflation dipped to 3.1 per cent in September, the Bank of England has forecast it to exceed 4 per cent by the end of the year, 2 percentage points higher than its target. UK banks and building societies have already started to increase mortgage rates in response to rising inflation, signalling an end to the era of ultra-low borrowing costs and piling further pressure on household finances.

In the USA, shortages throughout the supply chains on which corporate America depends are also causing concern. These issues are translating into widespread inflationary pressure, disrupting operations and forcing companies to raise prices for customers. Pressure on every link in the supply chain, from factory closures triggered by COVID-19 outbreaks to trouble finding enough staff to unload trucks, is rippling across sectors, intensifying questions about the threat that inflation poses to robust consumer spending and rebounding corporate earnings. Reflecting concern over weaker levels of global economic growth despite rising inflationary pressures, US figures published at the end of October showed the world’s largest economy added just 194 000 jobs in September, far fewer than expected.

There are also fears raised over high levels of corporate debt, including in China at the embattled property developer Evergrande, where worries over its ability to keep up with debt payments have rippled through global markets. There are major concerns that Evergrande could pose risks to the wider property sector, with potential spill-overs internationally. However, it is argued that the British banking system has been shown in stress tests to be resilient to a severe economic downturn in China and Hong Kong.

Central bank responses

The sharpest consumer-price increases in years have evoked different responses from central banks. Many have raised interest rates, but two that haven’t are the most prominent in the global economy: the Federal Reserve and the European Central Bank. These differences in responses reflect differing opinions as to whether current price increases will feed further inflation cycles or simply peter out. For those large central banks, they are somewhat relying on households keeping faith in their track record of keeping inflation low. There is also an expectation that there are enough underutilised workers to ensure that wage inflation is kept low.

However, other monetary authorities worry that they have not yet earned the record of keeping inflation low and are concerned about the risk of wage inflation. In addition, in poorer countries there is a larger share of spending that goes on essentials such as food and energy. These have seen some of the highest price increases, so policy makers are going to be keen to stamp down on the inflation.

The Federal Reserve is expected to announce that it will start phasing out its $120bn monthly bond-buying programme (quantitative easing) as it confronts more pronounced price pressures and predictions that interest rates will be lifted next year. However, no adjustments are expected to be made to the Fed’s main policy rate, which is tethered near zero. Whilst financial markets are betting on an rise in Bank Rate by the Bank of England as early as next month, spurred by comments from Governor Andrew Bailey in mid-October that the central bank would ‘have to act’ to keep a lid on inflation.

Outlook for the UK

The Bank of England’s Chief Economist, Huw Pill, has warned that high rates of inflation could last longer than expected, due to severe supply shortages and rising household energy bills. He said inflationary pressures were still likely to prove temporary and would fall back over time as the economy adjusted after disruption caused by COVID and Brexit. However, he warned there were growing risks that elevated levels of inflation could persist next year.

The looming rise in borrowing costs for homeowners will add further pressure to family finances already stretched by higher energy bills and surging inflation. According to the Institute for Fiscal Studies, it is expected that households will face years of stagnating living standards, with predictions showing that households would on average be paying £3000 more each year in taxes by 2024/25, with the biggest impact felt by higher earners.

Investors are also reacting to concerns and have pulled $9.4bn out of UK-focused equity funds this year after hopes that a COVID-19 vaccination drive will fuel a vigorous economic recovery were overshadowed by questions about slow growth and high inflation. It is suggested that there is a general sense of caution about the UK when it comes to investing globally, driven by monetary, fiscal and trade uncertainties.

Given all the elements contributing to this outlook, The IMF has forecast that the UK will recover more slowly from the shocks of coronavirus than other G7 nations, with economic output in 2024 still 3 per cent below its pre-pandemic levels. Financial markets are predicting the Bank of England will lift interest rates as soon as the next MPC meeting. And while supply-chain bottlenecks and rising commodity prices are a global trend, the Bank’s hawkish stance has increased the possibility of a sharper slowdown in Britain than other developed markets, some analysts have said.

What next?

Some of the major central banks are poised to take centre stage when announcing their next monetary action, as it will reveal if they share the alarm about surging inflation that has gripped investors. Markets are betting that the Bank of England will begin raising interest rates, with Bank Rate expected to rise to around 1.25 per cent by the end of next year (from the current 0.1 per cent).

It is thought that the Fed will not raise interest rates just yet but will do so in the near future. Markets, businesses, and households globally will be waiting on the monetary decisions of all countries, as these decisions will shape the trajectory of the global economy over the next few years.

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Forecasts and commentary

Questions

  1. What is the definition of inflation?
  2. How is inflation measured?
  3. Using a diagram to aid your answers, discuss the difference between cost-push and demand-pull inflation.
  4. What are the demand-side and cost-side causes of the current rising inflation?
  5. Explain the impact an increase in interest rates has on the economy.

The global battle for fuel is expected to peak this winter. The combination of rising demand and a tightening of supply has sparked concerns of shortages in the market. Some people are worried about another ‘winter of discontent’. Gas prices have risen fivefold in Europe as a whole.

In the UK, consumers are likely to find that the natural gas needed to heat their homes this October will cost at least five times more than it did a year ago. This surge in wholesale gas prices has seen several UK energy suppliers stop trading as they are unable to make a profit. This is because of an energy price cap for some consumers and various fixed price deals they had signed with their customers.

There are thus fears of an energy crisis in the UK, especially if there is a cold winter. There are even warnings that during a cold snap, gas supply to various energy-intensive firms may be cut off. This comes at a time when some of these industries are struggling to make a profit.

Demand and supply

The current situation is a combination of long- and short-term factors. In spring 2020, the demand for gas actually decreased due to the pandemic. This resulted in low gas prices, reduced UK production and delayed maintenance work and investment along global supply chains. However, since early 2021, consumer demand for gas has soared. First, there was an increased demand due to the Artic weather conditions last winter. This was then followed by heatwaves in the USA and Europe over the summer, which saw an increase in the use of air conditioning units. With the increased demand combined with calm weather conditions, wind turbines couldn’t supply enough power to meet demand.

There has also been a longer-term impact on demand throughout the industry due to the move to cleaner energy. The transitioning to wind and solar has seen a medium-term increase in the demand for gas. There is also a long-term impact of the target for net zero economies in the UK and Europe. This has hindered investors’ willingness to invest in developing supplies of fossil fuels due the fact they could become obsolete over the next few decades.

Nations have also been unable to build up enough supplies for winter. This is partly due to Europe’s domestic gas stocks having declined by 30% per cent in the past decade. This heightened situation is leading to concerns that there will be black-outs or cut-offs in gas this winter.

Importation of gas

A concern for the UK is that it has scant storage facilities with no long-term storage. The UK currently has very modest amounts of storage – less than 6% of annual demand and some five times less than the average in the rest of Europe. It has been increasingly operating a ‘just-in-time model’, which is more affected by short-term price fluctuations in the wholesale gas market. With wind power generation remaining lower than average during summer 2021, more gas than usual has been used to generate electricity, leaving less gas to go into storage.

However, some argue that the problem is not just the UK’s physical supply of gas but demand for gas from elsewhere. Around half of the UK’s supply comes from its own production sites, while the rest is piped in from Europe or shipped in as liquefied natural gas (LNG) from the USA, Qatar and Russia. In 2019, the UK imported almost 20% of its gas through LNG shipments. However, Asian gas demand has grown rapidly, expanding by 50% over the past decade. This has meant that LNG has now become much harder to secure.

The issue is the price the UK has to pay to continue receiving these supplies. Some in the gas industry believe the price surge is only temporary, caused by economic disruptions, while many others say it highlights a structural weakness in a continent that has become too reliant on imported gas. It can be argued that the gas crisis has highlighted the lack of a coherent strategy to manage the gas industry as the UK transitions to a net zero economy. The lack of any industry investment in new capacity suggests that there is currently no business case for new long-term storage in the UK, especially as gas demand is expected to continue falling over the longer term.

Impact on consumers and industry

Gas prices for suppliers have increased fivefold over the past year. Therefore, many companies face a considerable rise in their bills. MSome may need to reduce or pause production – or even cease trading – which could cause job losses. Alternatively, they could pass on their increased costs to customers by charging them higher prices. Although energy-intensive industries are particularly exposed, every company that has to pay energy bills will be affected. Due to the growing concerns about the security of winter gas supplies those industries reliant on gas, such as the fertiliser industry, are restricting production, threatening various supply chains.

Most big domestic gas suppliers buy their gas months in advance, meaning they will most likely pass on the higher price rises they have experienced in the past few months. The increased demand and decreased supply has already meant meant that customers have faced higher prices for their energy. The UK has been badly hit because it’s one of Europe’s biggest users of natural gas – 85% of homes use gas central heating – and it also generates a third of the country’s electricity.

The rising bills are particularly an issue for those customers on a variable tariff. About 15 million households have seen their energy bills rise by 12% since the beginning of October due to the rise in the government’s energy price cap calculated by the regulator, Ofgem. A major concern is that this increase in bills comes at a time when the need to use more heating and lighting is approaching. It also coincides with other price rises hitting family budgets and the withdrawal of COVID support schemes.

Government intervention – maximum pricing

If the government feels that the equilibrium price in a particular market is too high, it can intervene in the market and set a maximum price. When the government intervenes in this way, it sets a price ceiling on certain basic goods or services and does not permit the price to go above that set limit. A maximum price is normally set for reasons of fairness and to benefit consumers on low incomes. Examples include energy price caps to order to control fuel bills, rent controls in order to improve affordability of housing, a cap on mobile roaming charges within the EU and price capping for regional monopoly water companies.

The energy price cap

Even without the prospect of a colder than normal winter, bills are still increasing. October’s increase in the fuel cap means that many annual household fuel bills will rise by £135 or more. The price cap sets the maximum price that suppliers in England, Wales and Scotland can charge domestic customers on a standard, or default tariff. The cap has come under the spotlight owing to the crisis among suppliers, which has seen eleven firms fold, with more expected.

The regulator Ofgem sets a price cap for domestic energy twice a year. The latest level came into place on 1 October. It is a cap on the price of energy that suppliers can charge. The price cap is based on a broad estimate of how much it costs a supplier to provide gas and electricity services to a customer. The calculation is mainly made up of wholesale energy costs, network costs such as maintaining pipes and wires, policy costs including Government social and environmental schemes, operating costs such as billing and metering services and VAT. Therefore, suppliers can only pass on legitimate costs of supplying energy and cannot charge more than the level of the price cap, although they can charge less. A household’s total bill is still determined by how much gas and electricity is used.

  • Those on standard tariffs, with typical household levels of energy use, will see an increase of £139.
  • People with prepayment meters, with average energy use, will see an annual increase of £153.
  • Households on fixed tariffs will be unaffected. However, those coming to the end of a contract are automatically moved to a default tariff set at the new level.

Ordinarily, customers are able to shop around for cheaper deals, but currently, the high wholesale prices of gas means that cheaper deals are not available.

Despite the cap limiting how much providers can raise prices, the current increase is the biggest (and to the highest amount) since the cap was introduced in January 2019. As providers are scarcely making a profit on gas, there are concerns that a further increase in wholesale prices will cause more suppliers to be forced out of business. Ofgem said that the cap is likely to go up again in April, the next time it is reviewed.

Conclusion

The record prices being paid by suppliers and deficits in gas supply across the world have stoked fears that the energy crisis will get worse. It comes at a time when households are already facing rising bills, while some energy-intensive industries have started to slow production. This has started to dent optimism around the post-pandemic economic recovery.

Historically, UK governments have trusted market mechanisms to deliver UK gas security. However, consumers are having to pay the cost of such an approach. The price cap has meant the UK’s gas bills have until now been typically lower than the EU average. However, the rise in prices comes on top of other economic problems such as labour shortages and increasing food prices, adding up to an unwelcome rise in the cost of living.

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UK government/Ofgem

Questions

  1. Using a supply and demand diagram, illustrate what has happened in the energy market over the past year.
  2. What are the advantages and disadvantages of government intervention in a free market?
  3. Explain why it is necessary for the regulator to intervene in the energy market.
  4. Using the concept of maximum pricing, illustrate how the price cap works.


The transition towards clean energy in combination with a shortfall in supply has seen the price of raw uranium, also known as ‘yellowcake’, rise almost 60 per cent in recent weeks. It is now trading at over $50 a pound – a nine-year high. The market has been described as being at a ‘tipping point’. Given the recent boom in the market, the current conditions could tip the balance towards an era of rising uranium prices.

What is uranium?

Uranium is a heavy metal which has been used as a source of concentrated energy for over 60 years. Uranium ore can be mined from underground, milled, and then sold. It is then used in a nuclear reactor for electricity generation. About 10% of the world’s electricity is generated from uranium in nuclear reactors. There are some 445 nuclear reactors operating in 32 countries. It is the most energy-dense and efficient fuel source we have, with just ten uranium pellets able to power the average household for an entire year.

In March 2011, Japan’s most powerful earthquake on record triggered a tsunami, which then caused a meltdown at a nuclear power plant in Fukushima. It forced residents from their homes as radiation leaked from the plant. Since the Fukushima accident, uranium prices had been on a downtrend trend – enough to force several miners to suspend or scale back operations.

However, there has been a 42 per cent increase in the price of the metal in the first nine months of 2021 alone.

Demand for uranium

Since launching in July, a new investment trust, run by Canadian asset manager Sprott, has snapped up about 6m pounds of physical uranium, worth about $240m. This aggressive buying has helped push prices of uranium to more than $40 per pound, up from $30 at the start of the year. In the first part of September alone, prices surged by around 40%, outperforming all other major commodities. In just a few weeks, millions of pounds of supply were scooped up by the Sprott Physical Uranium Trust. This puts pressure on utilities that need to secure supplies of the commodity for electricity generation.

This increased demand is occurring at precisely the same time as countries and companies around the world are committing to net-zero carbon targets. As a result, nuclear power companies are now facing competition for supplies of uranium from financial investors, who are betting on sharply higher prices and demand for the radioactive material used to fuel reactors. This boost in demand is said to be due to uranium being used as a low-carbon energy source, despite the radioactive waste problem that comes with it. Investors are betting that nuclear power will be a key part of the move away from fossil fuels.

Production from world uranium mines has in recent years supplied 90% of the requirements of power utilities for uranium, with the current global mine supply expected to be about 125m pounds for 2021. In addition, there are secondary sources such as commercial and military stockpiles. However, according to the World Nuclear Association, demand for uranium is expected to climb from about 162m pounds this year to 206m pounds in 2030, and to 292m pounds by 2040. This is largely driven by increased power generation in China. China is planning a big increase in its nuclear power capacity over the next decade as the country seeks to cut its emissions.

Supply of uranium

Although uranium is relatively abundant in the Earth’s crust, not all uranium deposits are economically recoverable. While some countries have uranium resources that can be mined profitably when prices are low, others do not. Kazakhstan is the largest producer of uranium and in 2019 produced more uranium than the second, third, and fourth-largest producers combined.

The big issue is that supply to the market is falling significantly. For deliveries that would start in 2022, Kazakh producer, Kazatomprom, is now discussing the possibility of supplying the metal directly to Sprott. However, it also warned of the risk that its mines would not reach their output target for 2021, and it said earlier this year that it would keep its production at reduced levels through 2023. In addition to this, the recent surge in buying is also reducing the inventories that accumulated after the Fukushima accident.

The supply of uranium is set to fall 15 per cent by 2025 and by 50 per cent by 2030. This is mainly due to a lack of investment in new mines. The lack of new uranium mines will mean the price has to move higher. Namibian mines, accounting for 8 per cent of world supply, are approaching the end of their lives. Cameco of Canada, another important source, has shut one large pit because of uneconomic prices. According to BMO Capital, a mine supply deficit since 2019 will continue.

Supply has also been affected by the pandemic. The boom in demand has coincided with historically low prices and pandemic-driven mine disruptions, prompting uranium producers to buy from the spot market to fulfil long-term contracts with consumers. Some of the largest mining operations in Canada and Kazakhstan had to suspend production temporarily due to a shortage of workers.

Adding to the security of supply concerns is the role of commercial and state-owned entities in the uranium market. Uranium is a highly trade-dependent commodity with international trade policies highlighting the disconnect between where uranium is produced and where it is consumed. About 80% of primary production comes from countries that consume little-to-no uranium, and nearly 90% of uranium consumption occurs in countries that have little-to-no primary production. As a result, government-driven trade policies can be particularly disruptive for the uranium market. It is argued that the risk to uranium supply may create a renewed focus on ensuring availability of long-term supply to fuel nuclear reactors.

The role of financial players

Financial players have been accelerating the recent recovery in the price of uranium, with large-scale speculative buying and withholding of supply. But it can be argued that this would not have occurred if there were not a fundamental and substantial shortage.

If investors keep buying uranium, analysts expect utility companies will come under pressure to replace long-term supply agreements before they expire. At the moment, long-term contracts cover 98 per cent of the uranium needed by US utility companies. But that figure drops to 84 per cent next year, and 55 per cent by 2025, according to uranium investment company, Yellow Cake.

As annual supply declines, demand for uranium from producers and financial players increases, and with trade policy potentially restricting access to some markets, it is believed the pounds available in the spot market will not be adequate to satisfy the growing backlog of long-term demand. As a result, companies expect there will be increased competition to secure uranium under long-term contracts on terms that will ensure the availability of reliable primary supply to meet growing demand.

What will the future look like?

Many countries are turning their attention to nuclear power in order to become net-zero economies. Even in Japan, nuclear generation has slowly been returning. It is argued that nuclear power is needed to some degree for the country to achieve its pollution-curbing goals. However, not all nations are re-embracing nuclear. Germany, for example, is set to shut its last reactor next year.

The concern is whether the recent gains in investor demand is enough to underpin the market. It can be argued that even before the recent price rally started, demand for uranium from the investment sector was already growing. However, observers of the market have suggested that just as quickly as uranium skyrocketed, prices may now be hitting the brakes. Producer stocks that got swept up in the frenzy seem to have peaked. In addition, the world’s top uranium miner Kazatomprom has warned that the recent price action was being fuelled by financial investors rather than the utilities that use the radioactive metal as fuel in their reactors. On the other hand, it is argued that this pickup in the spot market will be the catalyst to push more utilities to get involved in term contracting.

Despite the impact of the pandemic on global energy demand, it is now growing again. Gas and other energy shortages are being seen and the price of gas has been rising rapidly. This rise in energy prices plus a focus on carbon-free generation is likely to continue driving demand for nuclear power and hence for uranium. In addition, producers have warned of supply shortages in the long term as investors scoop up physical inventory and new mines are not starting quickly enough. Thus nuclear’s growing role in the clean energy transition, in addition to a supply shortfall, could turn the tide for the uranium industry.

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Data

Questions

  1. Using the uranium market as an example, describe the relationship between an increase in demand and the market price.
  2. Explain whether the supply of uranium would be price elastic or inelastic in (a) the short run; (b) the long run.
  3. What is the role of speculation in determining the recent movements in the price of uranium and likely future price movements?
  4. Given your answers to the above questions, draw supply and demand diagrams to illustrate (a) the recent increase in the market price of uranium; (b) the likely price of uranium in five years from now.

With the coronavirus pandemic having reached almost every country in the world, the impact on the global economy has been catastrophic. Governments have struggled balancing the spread of the virus and keeping the economy afloat. This has left businesses counting the costs of various control measures and numerous lockdowns. The crisis has particularly affected small and medium-sized enterprises (SMEs), causing massive job losses and longer-term economic scars. Among these is an increase in the market power held by dominant firms as they emerge even stronger while smaller rivals fall away.

It is feared that with the full effects of the pandemic not yet realised, there may well be a wave of bankruptcies that will hit SMEs harder than larger firms, particularly in the most affected industries. Larger firms are most likely to be more profitable in general and more likely to have access to finance. Firm-level analysis using Orbis data, which includes listed and private firms, suggests that the pandemic-driven wave of bankruptcies will lead to increases in industry concentration and market power.

What is market power?

A firm holds a dominant position if its power enables it to operate within the market without taking account of the reaction of its competitors or of intermediate or final consumers. The key role of competition authorities around the world is to protect the public interest, particularly against firms abusing their dominant positions.

The UK’s competition authority, the Competition and Markets Authority (CMA) states:

Market power arises where an undertaking does not face effective competitive pressure. …Market power is not absolute but is a matter of degree; the degree of power will depend on the circumstances of each case. Market power can be thought of as the ability profitably to sustain prices above competitive levels or restrict output or quality below competitive levels. An undertaking with market power might also have the ability and incentive to harm the process of competition in other ways; for example, by weakening existing competition, raising entry barriers, or slowing innovation.

It can be hard to distinguish between a rapidly growing business and growing concentration of market power. In a pandemic, these distinctions can become even more difficult to discern, since there really is a deep need for a rapid deployment of capital, often in distressed situations. It is also not always evident whether the attempt to grow is driven by the need for more productive capacity, or by the desire to engage in financial engineering or to acquire market power.

It may be the case that, as consumers, we simply have no choice but to depend on various monopolies in a crisis, hoping that they operate in the public interest or that the competition authorities will ensure that they do so. With Covid-19 for example, economies will have entered the pandemic with their existing institutions, and therefore the only way to operate may be through channels controlled by concentrated power. Market dominance can occur for what seem to be good, or least necessary, reasons.

Why is market power a problem?

Why is it necessarily a problem if a successful company grows bigger than its competitors through hard work, smart strategies, and better technology adoption? It is important to recognise that increases in market power do not always mean an abuse of that market power. Just because a company may dominate the market, it does not mean there is a guaranteed negative impact on the consumer or industry. There are many advantages to a monopoly firm and, therefore, it can be argued that the existence of a market monopoly in itself should not be a cause of concern for the regulator. Unless there is evidence of past misconduct of dominance, which is abusive for the market and its stakeholders, some would argue that there is no justification for any involvement by regulators at all.

However, research by the International Monetary Fund concluded that excessive market power in the hands of a few firms can be a drag on medium-term growth, stifling innovation and holding back investment. Given the severity of the economic impact of the pandemic, such an outcome could undermine the recovery efforts by governments. It could also prevent new and emerging firms entering the market at a time when dynamism is desperately needed.

The ONS defines business dynamism as follows:

Business dynamism relates to measures of birth, growth and decline of businesses and its impact on employment. A steady rate of business creation and closure is necessary for an economy to grow in the long-run because it allows new ideas to flourish.

A lack of business dynamism could lead to a stagnation in productivity and wage growth. It also affects employment through changes in job creation and destruction. In this context, the UK’s most recent unemployment rate was 5%. This is the highest figure for five years and is predicted to rise to 6.5% by the end of 2021. Across multiple industries, there is now a trend of falling business dynamism with small businesses failing to break out of their local markets and start-up companies whose prices are undercut by a big rival. This creates missed opportunities in terms of growth, job creation, and rising incomes.

There has been a rise in mergers and acquisitions, especially amongst dominant firms, which is contributing to these trends. Again, it is important to recognise that mergers and acquisitions are not in themselves a problem; they can yield cost savings and produce better products. However, they can also weaken incentives for innovation and strengthen a firm’s ability to charge higher prices. Analysis shows that mergers and acquisitions by dominant firms contribute to an industry-wide decline in business dynamism.

Changes in market power due to the pandemic

The IMF identifies key indicators for market power, such as the percentage mark-up of prices over marginal cost, and the concentration of revenues among the four biggest players in a sector. New research shows that these key indicators of market power are on the rise. It is estimated that due to the pandemic, this increase in market dominance could now increase in advanced economies by at least as much as it did in the fifteen years to the end of 2015.

Global price mark-ups have risen by more than 30%, on average, across listed firms in advanced economies since 1980. And in the past 20 years, mark-up increases in the digital sector have been twice as steep as economy-wide increases. Increases in market power across multiple industries caused by the pandemic would exacerbate a trend that goes back over four decades.

It could be argued that firms enjoying this increase in market share and strong profits is just the reward for their growth. Such success if often a result of innovation, efficiency, and improved services. However, there are growing signs in many industries that market power is becoming entrenched amid an absence of strong competitors for dominant firms. It is estimated that companies with the highest mark-ups in a given year, have an almost 85 percent chance of remaining a high mark-up firm the following year. According to experts, some of these businesses have created entry barriers – regulatory or technology driven – which are incredibly high.

Professor Jayant R. Varma, a member of the MPC of the Reserve Bank of India (RBI), observed that in several sectors characterised by an oligopolistic core and a competitive periphery, the oligopolistic core has weathered the pandemic and it is the competitive periphery that has been debilitated. Rising profits and profit margins, improving capacity utilisation and lack of new capacity additions create ripe conditions for the oligopolistic core to start exercising pricing power.

The drivers and macroeconomic implications of such rises in market power are likely to differ across economies and individual industries. Even in those industries that benefited from the crisis, such as the digital sector, dominant players are among the biggest winners. The technology industry has been under the microscope in recent years, and increasingly the big tech firms are under scrutiny from regulators around the world. The market disruptors that displaced incumbents two decades ago have become increasingly dominant players that do not face the same competitive pressures from today’s would-be disruptors. The pandemic is adding to powerful underlying forces such as network effects and economies of scale and scope.

A new regulator that aims to curb this increasing dominance of the tech giants has been established in the UK. The Digital Markets Unit (DMU) will be based inside the Competition and Markets Authority. The DMU will first look to create new codes of conduct for companies such as Facebook and Google and their relationship with content providers and advertisers. Business Secretary Kwasi Kwarteng said the regime will be ‘unashamedly pro-competition’.

Policy Responses

The additions in regulation in the UK fall in line with the guidance from the IMF. It recommends that adjustments to competition-policy frameworks need to be made in order to minimise the adverse effects of market dominance. Such adjustments must, however, be tailored to national circumstances, both in general and to address the specific challenges raised by the surge of the digital economy.

It recommends the following five actions:

  • Competition authorities should be increasingly vigilant when enforcing merger control. The criteria for competition authorities to review a deal should cover all relevant cases – including acquisitions of small players that may grow to compete with dominant firms.
  • Second, competition authorities should more actively enforce prohibitions on the abuse of dominant positions and make greater use of market investigations to uncover harmful behaviour without any reported breach of the law.
  • Greater efforts are needed to ensure competition in input markets, including labour markets.
  • Competition authorities should be empowered to keep pace with the digital economy, where the rise of big data and artificial intelligence is multiplying incumbent firms’ advantage. Facilitating data portability and interoperability of systems can make it easier for new firms to compete with established players.
  • Investments may be needed to further boost sector-specific expertise amid rapid technological change.

Conclusion

The crisis has had a significant impact on all businesses, with many shutting their doors for good. However, there has been a greater negative impact on SMEs. Even in industries that have flourished from the pandemic, it is the dominant firms that have emerged the biggest winners. There is concern that the increasing market power will remain embedded in many economies, stifling future competition and economic growth. While the negative effects of increased market power have been moderate so far, the findings suggest that competition authorities should be increasingly vigilant to ensure that these effects do not become more harmful in the future.

Reviews of competition policy frameworks have already begun in some major economies. Young, high-growth firms that innovate and create high-quality jobs deserve a level playing field and a fair chance to succeed. Support directed to SMEs is important, as many small firms have been unable to benefit from government programmes designed to help firms access financing during the pandemic. Policymakers should act now to prevent a further, sharp rise in market power that could hold back the post-pandemic recovery.

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Official documents

Questions

  1. What are the arguments for and against the assistance of a monopoly?
  2. What barriers to entry may exist that prevent small firms from entering an industry?
  3. What policies can be implemented to limit market power?
  4. Define and explain market dynamism.

Throughout the pandemic, the fight against COVID-19 has often been framed in terms of striking a balance between the health of the public and the health of the economy. This leads to the assumption that a trade-off must exist between these two objectives. Countries, therefore, have to decide between lives and livelihoods. However, one year on since lockdowns swept the globe the evidence suggests that the trade-off between sacrificing lives and sacrificing the economy is not necessarily clear cut.

Controlling the virus

Restrictions such as social distancing and lockdowns were introduced in order to minimise the spread of the virus, prevent hospitals from being overwhelmed, and ultimately save lives. However, as these measures are put in place, schools were closed, businesses and factories stopped operating, and economic activity shrank. This would suggest therefore, that society inevitably faces a trade-off between lost lives versus lost livelihoods.

It could be argued, therefore, that in the short run these interventions create a ‘health–wealth trade-off’. The lockdown restrictions save lives by preventing transmission, but they came at the cost of lost output, income and therefore GDP. This would also imply that the trade-off works in reverse when the lockdown restrictions are eased. As measures are relaxed, the economy can begin to recover but at the cost of an increased threat of the virus spreading again.

What are the costs?

In order to work out if a trade-off exists and what costs are involved, there must be a monetary value placed on human life. While this may seem unethical, governments, civil courts, regulatory bodies and companies do it all the time. The very existence of the life insurance industry is testament to the fact that human lives can be measured in monetary terms. One approach to measuring valuing life, commonly used by economists who conduct cost-benefit analyses, is the ‘value of statistical life’. It measures the loss or gain that arises from changes in the incidence of death, by eliciting people’s willingness to pay for small reductions in the probability of death, or their willingness to accept compensation in exchange for tolerating a small increase in the chance of death. (see the blog Lockdown – again. Is it worth it?)

Take the example of a complete lockdown. The potential number of lives saved can be estimated based on infection and fatality rates estimated from epidemiological models. This can then be multiplied by value of statistical life to compute the monetary value of saved lives. If this number exceeds the economic costs of a complete lockdown, then we know that it is desirable.

The trade-off between lost lives versus the economy is often erroneously viewed as an all-or-nothing choice between complete lockdown versus zero restrictions. However, in reality, there is a continuum in stringency of restrictions and it is not an all-or-nothing comparison.

Death rates vs downturns

In order to explore the existence of this trade-off, we can compare the health and economic impacts of the pandemic in different countries. If such a trade-off exists, then countries with lower death rates should have experienced larger economic downturns. However, when comparing the COVID-19 death rates with GDP data, the result is the opposite: countries that have managed to protect their population’s health in the pandemic have generally also protected their economy too. This suggests that there was never a simple binary trade-off between the two factors. Those countries that experienced the biggest first wave of excess deaths, also had the biggest hits to the economy.

The UK was the hardest hit of similar countries on both measures within the G7 group of industrialised countries. The shape of the recession in the UK from the pandemic and lockdowns was extraordinary and historic. However, it was also unique as there was a very sharp fall followed by a rapid rebound. Over 2020, GDP saw the largest hit in three centuries; larger than any single year of the Great Wars or the 1920s Depression.

Studies of the declines in GDP contradict the idea of a trade-off, showing that countries that suffered the most severe economic downturns, such as Peru, Spain and the UK, were generally among the countries with the highest COVID-19 death rates. There are countries that have experienced the reverse too; Taiwan, South Korea, and Lithuania all experienced modest declines in economic output but have also managed to keep the death rate low.

It should also be noted that some countries that had similar falls in GDP experienced very different death rates from each other. When comparing the USA and Sweden with Denmark and Poland, they all saw similar declines in the economy with contractions of around 8–9%. However, the USA and Sweden recorded 5–10 times more deaths per million. This therefore suggests that there is no clear trade-off between the health of the population and the health of the economy.

There will be many different factors that impact on the death rate for each individual country and by how much the economy has been affected. Such factors will even go beyond the policy decisions that have been made throughout the pandemic about how best to suppress the transmission of the virus. However, from the data available, there is no clear evidence to suggest that a trade-off between the health and the economy exists. If anything, it suggests that the relationship works in the opposite direction.

Save the economy by saving lives

Given the arguments against the existence of the trade-off, it could be argued that in order to limit the economic damage caused by the pandemic, the focus needs to start and end with controlling the spread of the virus. Experiments that have been conducted across the world definitively show that no country can prevent the economic damage without first addressing the pandemic that causes it. Those countries that acted swiftly in implementing harsh measures to control the virus, are now reopening in stages and their economies are growing. Countries such as China, Australia, New Zealand, Iceland, and Singapore, which all invested primarily in swift coronavirus suppression, have effectively eliminated the virus and are seeing their economies begin to grow again.

China, in particular, stands out amongst this group of countries. The Chinese authorities acted very quickly, and firmly, but also the levels of compliance of the population have been very high. However, it could be argued that few countries possess the infrastructure that exists in China to facilitate such high compliance. The fact that the lockdown in China was so effective reduced both losses to the economy and the need for stimulus measures. China is also one of the few countries that have achieved a “V-shaped” recovery. Countries such as Korea, Norway and Finland also appear to have responded relatively well.

Most of the countries that prioritised supporting their economies and resisted, limited, or prematurely curtailed interventions to control the pandemic faced runaway rates of infection and further national lockdowns. The examples of the UK, the USA and Brazil are often quoted, with many arguing that these countries responded too late and too haphazardly. Both have experienced high numbers of deaths.

Conclusion

Discussions around the responses to the pandemic and what appropriate action should be taken have predominately been about how countries can strike the balance between protecting people’s health and protecting the economy. However, from observing the GDP data available there is no clear evidence of a definitive trade-off; rather the relationship between the health and economic impacts of the pandemic goes in the opposite direction. As well as saving lives, countries controlling the outbreak effectively may have adopted the best economic strategy too. It is important to recognise that many factors have affected the death rate and the impact on the economy, and the full impacts of the pandemic are yet to be seen. However, it is by no means clear that the trade-off between greater emphasis on sacrificing lives or sacrificing the economy is as real as has been suggested. If such a trade-off does exist, it is, at best, a weak one.

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Questions

  1. Define and explain the difference between a substitute and complementary good.
  2. Using your answer to question 1, describe the existence of a trade-off.
  3. Discuss the reasons why the trade-off between health and the economy would work in the opposite direction.