The UN’s Intergovernmental Panel on Climate Change (IPCC) has just published the first part of its latest seven-yearly Assessment Report (AR6) on global warming and its consequences (see video summary). The report was prepared by 234 scientists from 66 countries and endorsed by 195 governments. Its forecasts are stark. World temperatures, already 1.1C above pre-industrial levels, will continue to rise. This will bring further rises in sea levels and more extreme weather conditions with more droughts, floods, wildfires, hurricanes and glacial melting.
The IPCC looked at a number of scenarios with different levels of greenhouse gas emissions. Even in the most optimistic scenarios, where significant steps are taken to cut emissions, global warming is set to reach 1.5C by 2040. If few or no cuts are made, global warming is predicted to reach 4.4C by 2080, the effects of which would be catastrophic.
The articles below go into considerable detail on the different scenarios and their consequences. Here we focus on the economic causes of the crisis and the policies that need to be pursued.
Global success in reducing emissions, although partly dependent on technological developments and their impact on costs, will depend largely on the will of individuals, firms and governments to take action. These actions will be influenced by incentives, economic, social and political.
Economic causes of the climate emergency
The allocation of resources across the world is through a mixture of the market and government intervention, with the mix varying from country to country. But both market and government allocation suffer from a failure to meet social and environmental objectives – and such objectives change over time with the preferences of citizens and with the development of scientific knowledge.
The market fails to achieve a socially efficient use of the environment because large parts of the environment are a common resource (such as the air and the oceans), because production or consumption often generates environmental externalities, because of ignorance of the environmental effects of our actions, and because of a lack of concern for future generations.
Governments fail because of the dominance of short-term objectives, such as winning the next election or appeasing a population which itself has short-term objectives related to the volume of current consumption. Governments are often reluctant to ask people to make sacrifices today for the future – a future when there will be a different government. What is more, government action on the environment which involves sacrifices from their own population, often primarily benefit people in other countries and/or future generations. This makes it harder for governments to get popular backing for such policies.
Economic systems are sub-optimal when there are perverse incentives, such as advertising persuading people to consume more despite its effects on the environment, or subsidies for industries producing negative environmental externalities. But if people can see the effects of global warming affecting their lives today, though fires, floods, droughts, hurricanes, rising sea levels, etc., they are more likely to be willing to take action today or for their governments to do so, even if it involves various sacrifices. Scientists, teachers, journalists and politicians can help to drive changes in public opinion through education and appealing to people’s concern for others and for future generations, including their own descendants.
Policy implications of the IPCC report
At the COP26 meeting in Glasgow in November, countries will gather to make commitments to tackle climate change. The IPCC report is clear: although we are on course for a 1.5C rise in global temperatures by 2040, it is not too late to take action to prevent rises going much higher: to avoid the attendant damage to the planet and changes to weather systems, and the accompanying costs to lives and livelihoods. Carbon neutrality must be reached as soon as possible and this requires strong action now. It is not enough for government to set dates for achieving carbon neutrality, they must adopt policies that immediately begin reducing emissions.
The articles look at various policies that governments can adopt. They also look at actions that can be taken by people and businesses, actions that can be stimulated by government incentives and by social pressures. Examples include:
- A rapid phasing out of fossil fuel power stations. This may require legislation and/or the use of taxes on fossil fuel generation and subsidies for green energy.
- A rapid move to green transport, with investment in charging infrastructure for electric cars, subsidies for electric cars, a ban on new petrol and diesel vehicles in the near future, investment in hydrogen fuel cell technology for lorries and hydrogen production and infrastructure, cycle lanes and various incentives to cycle.
- A rapid shift away from gas for cooking and heating homes and workplaces and a move to ground source heating, solar panels and efficient electric heating combined with battery storage using electricity during the night. These again may require a mix of investment, legislation, taxes and subsidies.
- Improvements in energy efficiency, with better insulation of homes and workplaces.
- Education, public information and discussion in the media and with friends on ways in which people can reduce their carbon emissions. Things we can do include walking and cycling more, getting an electric car and reducing flying, eating less meat and dairy, reducing food waste, stopping using peat as compost, reducing heating in the home and putting on more clothes, installing better insulation and draught proofing, buying more second-hand products, repairing products where possible rather than replacing them, and so on.
- Governments requiring businesses to conduct and publish green audits and providing a range of incentives and regulations for businesses to reduce carbon emissions.
It is easy for governments to produce plans and to make long-term commitments that will fall on future governments to deliver. What is important is that radical measures are taken now. The problem is that governments are likely to face resistance from their supporters and from members of the public and various business who resist facing higher costs now. It is thus important that the pressures on governments to make radical and speedy reductions in emissions are greater than the pressures to do little or nothing and that governments are held to account for their actions and that their actions match their rhetoric.
Articles
Some climate changes now irreversible, says stark UN reportChannel 4 News, Alex Thomson (9/8/21)
- Climate change: IPCC report is ‘code red for humanity’
BBC News, Matt McGrath (10/8/21)
- Climate change: Five things we have learned from the IPCC report
BBC News, Matt McGrath (10/8/21)
- Climate Scientists Reach ‘Unequivocal’ Consensus on Human-Made Warming in Landmark Report
Bloomberg Green, Eric Roston and Akshat Rathi (9/8/21)
- Climate change: Seven key takeaways from the IPCC climate change report
Sky News, Philip Whiteside (10/8/21)
- IPCC report: global emissions must peak by 2025 to keep warming at 1.5°C – we need deeds not words
The Conversation, Keith Baker (9/8/21)
- This is the most sobering report card yet on climate change and Earth’s future. Here’s what you need to know
The Conversation, Pep Canadell, Joelle Gergis, Malte Meinshausen, Mark Hemer and Michael Grose (9/8/21)
- IPCC report: how to make global emissions peak and fall – and what’s stopping us
The Conversation, Matthew Paterson (9/8/21)
- World’s 1.5C goal slipping beyond reach without urgent action, warns landmark IPCC climate report
Independent, Daisy Dunne and Louise Boyle (9/8/21)
- IPCC report: 14 ways to fight the climate crisis after publication of ‘Code Red’ warning
Independent, Harry Cockburn (10/8/21)
- Major climate changes inevitable and irreversible – IPCC’s starkest warning yet
The Guardian, Fiona Harvey (9/8/21)
- Climate scientists have done their bit. Now the pressure is on leaders for COP26.
CNN, Ivana Kottasová and Angela Dewan (10/8/21)
- 21 For 21: The Climate Change Actions Scotland Needs Now
Common Weal, Common Weal Energy Policy Group (9/8/21)
- How to build support for ambitious climate action in 4 steps
The Conversation, Sarah Sharma and Matthew Hoffmann (4/3/21)
- Scientists have finally added world politics to their climate models
Quartz, Michael J Coren (9/8/21)
Report
Questions
- Summarise the effects of different levels of global warming as predicted by the IPCC report.
- To what extent is global warming an example of the ‘tragedy of the commons’?
- How could prices be affected by government policy so as to provide an incentive to reduce carbon emissions?
- What incentives could be put in place to encourage people to cut their own individual carbon footprint?
- To what extent is game theory relevant to understanding the difficulties of achieving international action on reducing carbon emissions?
- Identify four different measures that a government could adopt to reduce carbon emissions and assess the likely effectiveness of these measures.
The coronavirus pandemic and the climate emergency have highlighted the weaknesses of free-market capitalism.
Governments around the world have intervened massively to provide economic support to people and businesses affected by the pandemic through grants and furlough schemes. They have also stressed the importance of collective responsibility in abiding by lockdowns, social distancing and receiving vaccinations.
The pandemic has also highlighted the huge inequalities around the world. The rich countries have been able to offer much more support to their people than poor countries and they have had much greater access to vaccines. Inequality has also been growing within many countries as rich people have gained from rising asset prices, while many people find themselves stuck in low-paid jobs, suffering from poor educational opportunities and low economic and social mobility.
The increased use of working from home and online shopping has accelerated the rise of big tech companies, such as Amazon and Google. Their command of the market makes it difficult for small companies to compete – and competition is vital if capitalism is to benefit societies. There have been growing calls for increased regulation of powerful companies and measures to stimulate competition. The problem has been recognised by governments, central banks and international agencies, such as the IMF and the OECD.
At the same time as the world has been grappling with the pandemic, global warming has contributed to extreme heat and wildfires in various parts of the world, such as western North America, the eastern Mediterranean and Siberia, and major flooding in areas such as western Europe and China. Governments again have intervened by providing support to people whose property and livelihoods have been affected. Also there is a growing urgency to tackle global warming, with some movement, albeit often limited, in implementing policies to achieve net zero carbon emissions by some specified point in the future. Expectations are rising for concerted action to be agreed at the international COP26 climate meeting in Glasgow in November this year.
An evolving capitalism
So are we seeing a new variant of capitalism, with a greater recognition of social responsibility and greater government intervention?
Western governments seem more committed to spending on socially desirable projects, such as transport, communications and green energy infrastructure, education, science and health. They are beginning to pursue more active industrial and regional policies. They are also taking measures to tax multinationals (see the blog The G7 agrees on measures to stop corporate tax avoidance). Many governments are publicly recognising the need to tackle inequality and to ‘level up’ society. Active fiscal policy, a central plank of Keynesian economics, has now come back into fashion, with a greater willingness to fund expenditure by borrowing and, over the longer term, to use higher taxes to fund increased government expenditure.
But there is also a growing movement among capitalists themselves to move away from profits being their sole objective. A more inclusive ‘stakeholder capitalism’ is being advocated by many companies, where they take into account the interests of a range of stakeholders, from customers, to workers, to local communities, to society in general and to the environment. For example, the Council for Inclusive Capitalism, which is a joint initiative of the Vatican and several world business and public-sector leaders, seeks to make ‘the world fairer, more inclusive, and sustainable’.
If there is to be a true transformation of capitalism from the low-tax free-market capitalism of neoclassical economists and libertarian policymakers to a more interventionist mixed market capitalism, where capitalists pursue a broader set of objectives, then words have to be matched by action. Talk is easy; long-term plans are easy; taking action now is what matters.
Articles and videos
- Why the next stage of capitalism is coming
BBC Future, Matthew Wilburn King (27/5/21)
- During the pandemic, a new variant of capitalism has emerged
The Guardian, Larry Elliott (30/7/21)
- When it comes to social and environmental justice, words don’t cut it
GreenBiz, C J Clouse (28/4/21)
- Introducing the Council for Inclusive Capitalism with the Vatican
Inclusive Capitalism (7/12/20)
- The State and Direction of Inclusive Capitalism
Saïd Business School, Ford Foundation and Deloitte Social Impact practice, Richard Barker, Mary Johnstone-Louis, Colin Mayer, Pradeep Prabhala, Noah Rimland Flower, Theodore Roosevelt Malloch, Tony Siesfeld and Peter Tufano (2018)
- Rising Market Power—A Threat to the Recovery?
IMF Blog, Kristalina Georgieva, Federico J Díez, Romain Duval and Daniel Schwarz (15/3/21)
- The Pandemic Alone Can’t Transform Capitalism
Jacobin, Ramaa Vasudevan (30/7/21)
- Down to earth: How entrepreneurs can collaborate to rejuvenate capitalism
EU-Startups, Luca Sabia (4/8/21)
Questions
- How similar is the economic response of Western governments to the pandemic to their response to the financial crisis of 2007–8?
- What do you understand by ‘inclusive capitalism’? How can stakeholders hold companies to account?
- What indicators are there of market power? Why have these been on the rise?
- How can entrepreneurs contribute to ‘closing the inequality gap for a more sustainable and inclusive form of society’?
- What can be done to hold governments to account for meeting various social and environmental objectives? How successful is this likely to be?
- Can inequality be tackled without redistributing income and wealth from the rich to the poor?
The UK and Australia are set to sign a free-trade deal at the G7 summit in Cornwall on 11–13 June. This will eventually give tariff-free access to each other’s markets, with existing tariffs being phased out over a 15-year period. It is the first trade deal not based on an existing EU template. The government hopes that it will be followed by trade deals with other countries, including New Zealand, Canada and, crucially, the USA.
But what are the benefits and costs of such a deal?
Trade and comparative advantage
The classic economic argument is that free trade allows countries to benefit from the law of comparative advantage. According to the law, provided opportunity costs of various goods differ in two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. In the case of the UK and Australia, the UK has a comparative advantage in products such as financial services and high-tech and specialist manufactured products. Australia has a comparative advantage in agricultural products, such as lamb, beef and wheat and in various ores and minerals. By increasing trade in these products, there can be a net efficiency gain to both sides and hence a higher GDP than before.
There is clearly a benefit to consumers in both countries from cheaper products, but the gains are likely to be very small. The most optimistic estimate is that the gain in UK GDP will be around 0.01% to 0.02%. Part of the reason is the physical distance between the two countries. For products such as meat, grain and raw materials, shipping costs could be relatively high. This might result in no cost advantage over imports from much nearer countries, such as EU member states.
But modern trade deals are less about tariffs, which, with various WTO trade rounds, are much lower than in the past. Many imports from Australia are already tariff free, with meat currently having a tariff of 12%. Modern trade deals are more about reducing or eliminating non-tariff barriers, such as differing standards and regulations. This is the area where there is a high degree of concern in the UK. Import-competing sectors, such as farming, fear that their products will be undercut by Australian imports produced to lower standards.
Costs of a trade deal
In a perfectly competitive world, with no externalities, labour mobile between sectors and no concerns about income distribution, eliminating tariffs would indeed provide an efficiency gain. But these conditions do not hold. Small farmers are often unable to compete with food producers with considerable market power. The danger is that by driving out such small farmers, food production and supply might not result in lower long-run prices. Much would depend on the countervailing power of supermarkets to continue bearing down on food costs.
But the question of price is probably the least worrying issue. Meat and grain is generally produced at lower standards in Australia than in the UK, with various pesticides, fertilisers and antibiotics being used that are not permitted in the UK (and the EU). Unless the trade deal can involve UK standards being enforced on products produced in Australia for export to the UK, UK farmers could be undercut by such imports. The question then would be whether labelling of imported food products could alert consumers to the different standards. And even if they did, would consumers simply prefer to buy the cheaper products? If so, this could be seen as a market failure with consumers not taking into account all the relevant health and welfare costs. Better quality food could be seen as a merit good.
Then there are the broader social issues of the protection of rural industries and societies. Labour is relatively immobile from farming and there could be a rise in rural unemployment, which could have local multiplier effects, leading to the decline of rural economies. Rural ways of life could be seriously affected, which imposes costs on local inhabitants and visitors.
Trade itself imposes environmental costs. Even if it were privately efficient to transport products half way around the world, the costs of carbon emissions and other pollution may outweigh any private gains. At a time when the world is becoming increasingly concerned about climate change, and with the upcoming COP26 conference in Glasgow in November, it is difficult to align such a trade deal with a greater commitment to cutting carbon emissions.
Articles
- UK makes free-trade offer to Australia despite farmers’ fears
BBC News (22/5/21)
- UK-Australia trade deal: What are the arguments for and against?
BBC News, Chris Morris (21/5/21)
- Australia–UK trade deal can help spur post-pandemic recovery
The Conversation, David Collins (20/5/21)
- Australia will set the precedent for UK trade deals
Prospect, David Henig (21/5/21)
- Britain beefs with Australian farmers as Boris Johnson backs trade deal
Sydney Morning Herald, Mike Foley and Bevan Shields (20/5/21)
- Boris Johnson defends Australia trade deal that will allow cheap foreign meat imports …
Mail Online, David Wilcock (19/5/21)
- City executives raise concerns over hidden costs to trade deals
Financial Times, Daniel Thomas (22/5/21)
- Australia trade deal: Ministers discuss British farmers’ concerns
BBC News (21/5/21)
- Boris Johnson Faces His First Real Brexit Trade Test
Bloomberg, Therese Raphael (21/5/21)
- UK-Australia trade deal could mean children and patients eating meat reared in ways illegal in UK, warn experts
Independent, Jane Dalton (11/5/21)
- Australian farmers rush to reassure UK over looming free trade agreement
The Guardian, Amy Remeikis (19/5/21)
- Brexit: Boris Johnson warned trade deal with Australia could ‘decimate’ British farming
Independent, Adam Forrest (20/5/21)
- Truss’s naivety on trade with Australia could leave the UK exposed
The Observer, Phillip Inman (22/5/21)
- ‘Irresponsible’ Australia trade deal will bring ruin for UK farmers, critics warn
The Observer, James Tapper and Toby Helm (23/5/21)
- Brexit: Boris Johnson rejects claim UK-Australia trade deal would see farmers ‘lose their livelihoods’
Sky News, Tom Rayner (19/5/21)
- Small farms have a huge role to play in our sustainable future
The Guardian, Charles, Prince of Wales (23/5/21)
- Farmers’ opposition to UK-Australia trade deal grows
BBC News, Claire Marshall (2/6/21)
- UK livestock farmers fear Australia trade deal will threaten way of life
Financial Times, Judith Evans and Sebastian Payne (8/6/21)
- The UK–Australia trade deal is not really about economic gain – it’s about demonstrating post-Brexit sovereignty
The Conversation, Tony Heron and Gabriel Siles-Brügge (18/6/21)
Questions
- Why might the UK government be very keen to sign a trade deal with Australia?
- Does the law of comparative advantage prove that freer trade is more efficient than less free trade? Explain.
- What externalities are involved in the UK trading with Australia? Are they similar to those from trading with the USA?
- If a trade deal resulted in lower food prices but a decline in rural communities, how would you establish whether this would be a ‘price worth paying’?
- If some people gain from a trade deal and others lose and if it were established that the benefits to the gainers were larger than the costs to the losers, would this prove that the deal should go ahead?
Back in October 2020 in the blog All change for the railways, we looked at the emergency measures for running the railways in Great Britain following the collapse in rail traffic because of the COVID-19 pandemic. We also looked ahead to plans for reorganising the railways, with the expectation that the current franchising system would be scrapped and replaced with a system whereby the train-operating companies (TOCs) would be awarded a contract to run rail services. They would be paid a performance-related fee. All ticket revenues would go to the government, which would bear the costs and the risks. While this would not be quite renationalisation, it would, in effect, be a contract system where private companies are paid to deliver a public service.
The Transport Secretary, Grant Shapps, has just announced the new system in a White Paper, which is indeed the anticipated contract system. The White Paper has drawn on the findings of the Williams Rail Review, independently chaired by Keith Williams.
The new system has the following features:
- A new public-sector body, Great British Railways (GBR), will be created which will eventually absorb Network Rail.
- GBR will produce five-year business plans. It will also develop a 30-year strategy to shape the long-term development of the railways and will include plans to decarbonise the whole rail network.
- It will be in charge of planning and operating rail infrastructure in England, including track, signalling, stations and depots.
- It will work closely with the devolved rail authorities in Scotland, Wales, London, Merseyside, and Tyne and Wear.
- It will set timetables, plan train operations, set most fares, sell tickets (at stations and on a new dedicated website) and collect revenues.
- The ticketing system will be reformed, with a single integrated system of fares across England, and potentially the devolved rail authorities too. The website will show the best and cheapest options for any given journey. New flexible season tickets will be introduced, allowing workers to travel on limited numbers of days: e.g. eight days in any 28-day period. Also, a new single compensation scheme will simplify the system for refunds.
- Private train-operating companies (TOCs) will run trains over particular routes. They will bid for Passenger Service Contracts (PSCs), which will be awarded by competitive tender. They will be paid a management fee, rather than receiving revenues from ticket sales. The fees will include performance incentives and penalties, which will depend on meeting targets for punctuality, reliability, safety and cleanliness.
- Rolling stock (trains, locomotives and freight wagons) will continue to be procured from the private sector, which will generally be leased to TOCs. It is hoped that by awarding PSCs for a number of years, TOCs will be encouraged to make large-scale procurements of rolling stock.
- GBR in England will be divided into five regional divisions, which will be ‘accountable to customers for their journeys; manage PSCs, stations and infrastructure; procure private partners, such as operators and contractors; manage budgets both locally and regionally; integrate track and train at a local level; work with and be responsive to the needs of local and regional partners, and integrate rail with other transport services’.
- GBR will be held to account by the Office of Rail and Road (ORR), which will monitor its performance.
In its White Paper, the government has recognised that, in many ways, rail privatisation has failed. Page 13 states:
Breaking British Rail into dozens of pieces was meant to foster competition between them and, together with the involvement of the private sector, was supposed to bring greater efficiency and innovation. Little of this has happened. Instead, the fragmentation of the network has made it more confusing for passengers, and more difficult and expensive to perform the essentially collaborative task of running trains on time.
But will the new system bring a better integrated, more efficient, punctual, reliable and greener railway, with more investment, an enlarged network and lower ticket prices? These are certainly aims of the White Paper. But a lot will depend on the details, yet to be finalised.
Crucially, it is not clear the extent to which the rail system will be subsidised. Will any subsidies internalise the positive externalities from rail travel? Also, it is not clear exactly what incentives and penalties will be introduced to encourage efficiency, punctuality, safety and cleanliness.
What is also not clear is the degree of contestability of rail routes and freight operations. Routes are contestable at the time of bidding for PSCs, with more efficient companies able to outbid the less efficient ones. But with changing conditions and the desire to maintain contestability, contracts need to be relatively short. However, it contracts are too short, there is no incentive for TOCs to invest in trains and infrastructure. Thus inherent in the PSC system is a tension between competition and investment.
It does seem that fares and tickets will be simpler, with greater use of ‘tapping in and out’ as in London and in many other countries, allowing fares to be capped when multiple journeys are made in any given time period. Ultimately, however, it is price, frequency, punctuality, comfort and reliability that are the crucial metrics. Success according to these will depend on how well GBR is run, how well the PSC system operates and how much the rail system is subsidised. The jury is out on these questions.
Video
Articles
- UK rail looks to private sector in biggest shake-up since 1990s
Financial Times, Philip Georgiadis, Andy Bounds and Jim Pickard (20/5/21)
- UK Rail Review – Williams-Shapps Plan for Rail
The National Law Review, Graeme McLellan, Richard Hughes and John Voorhees (21/5/21)
- Great British Railways: Franchises scrapped and changes to season tickets as part of major revamp to UK’s train network
Sky News, Paul Kelso (20/5/21)
- Great British Railways plan aims to simplify privatised system
The Guardian, Gwyn Topham (19/5/21)
- How is the UK government planning to change the rail network?
The Guardian, Gwyn Topham (20/5/21)
- Better rail services promised in huge shake-up
BBC News (21/5/21)
- Rail reform: What does the shake-up mean for you?
BBC News, Kevin Peachey (21/5/21)
- Great British Railways: New public body to take over all trains and track in biggest reforms since privatisation
Independent, Jon Stone (20/5/21)
- Great British Railways body has been announced to run industry – but what about Scotland?
The Scotsman, Alastair Dalton (20/5/21)
- There’s nothing ‘great’ about this new British Railways revamp
The Guardian, Simon Jenkins (20/5/21)
Documents
Questions
- Explain how the franchising system has worked. What problems have arisen with this system?
- If the proposed new system also involves contracts being awarded to train-operating companies, how is it better than the old franchising system?
- What were the Emergency Measures Agreements (EMAs) introduced in the pandemic and the Emergency Recovery Measures Agreements (ERMAs) which replaced them in September 2020? How similar are they to the proposed system of Passenger Service Contracts (PSCs) with train-operating companies?
- Identify the externalities involved in train travel? What is the best way of internalising them?
- Argue the case for and against making train travel cheaper by increasing subsidies.
- To what extent are individual rail routes natural monopolies? Does a franchising system overcome the problems associated with natural monopolies?
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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Questions
- What are the arguments for and against the assistance of a monopoly?
- What barriers to entry may exist that prevent small firms from entering an industry?
- What policies can be implemented to limit market power?
- Define and explain market dynamism.