A few months ago, in a post on this site I reported that the Competition Commission (CC) had completed their provisional investigation into the concrete and cement market in Great Britain. As I discussed, they concluded that coordination between the main cement producers was resulting in high prices. They are particularly concerned about the impact of high prices in this market because:
Cement is an essential product for the construction and building sectors and the amount of such work that is funded by the public purse only underlines the importance of ensuring that customers get better value for money. We believe our measures can bring about a substantial, swift and lasting increase in competition in this economically vital market.
The next step was for the CC to consider how they could remedy the situation and hopefully improve competition in the market.
Earlier this month, the CC announced the remedies they intend to impose. Having previously suggested that they intended to impose hard-hitting measures, they have been true to their word. The market leader, Lafarge Tarmac, will be required to sell one of its cement plants to facilitate a new entrant into the market. According to Professor Martin Cave, the CC’s Deputy Chairman who led the inquiry:
We believe that the entry of a new, independent cement producer is the only way to disturb the established structure and behaviour in this market which has persisted for a number of years and led to higher prices for customers.
In addition, the CC is also putting in place measures to limit the publication of production data and price announcements. It is hoped that these measures will reduce transparency in the market.
However, Lafarge Tarmac disagrees with the sale they are being forced to make. This is in part because, as I discussed in the earlier post, they had previously been allowed by the CC to form a joint venture (JV) with one its main rivals:
We are disappointed that the Competition Commission has asked Lafarge Tarmac to divest another cement plant only a year after it allowed the creation of the JV. This is not reasonable or proportionate and we have not been given a fair opportunity to defend our position.
In addition, Lafarge Tarmac is quoted in the above article as suggesting that the end result of the CC’s intervention will be harm to consumers. It will be extremely interesting to monitor how this market develops.
Articles
Competition Commission confirms plan for new cement producer The Construction Index, (14/01/14)
Competition Commission improves competition in the UK. Again. Global Cement, (22/01/14)
Report
Aggregates, cement and ready-mix concrete market investigation, Final report, Competition Commission, (14/01/14)
Questions
- Why might the publication of production data and price announcements help to facilitate coordination between firms?
- Would you expect the new entrant or the measures to limit the publication of production data and price announcements to have more impact on competition in the market?
- Using a supply and demand model, describe the impact the CC’s intervention could have on the construction market.
In December 2013, Uruguay passed a law permitting the growing, distribution and consumption of marijuana. The legislation comes into effect in April 2014. The state will regulate the industry to ensure good quality strains of the crop are grown and sold. It will also tax the industry.
Uruguay is the first country to legalise cannabis, but in July 2012, Colorado and Washington states in the USA passed laws permitting the sale and possession of small amounts of the drug for recreational use. (It was already legal to possess the drug for medical use.) The laws took effect a few months later. It is heavily taxed, however, especially in Washington, where it is taxed at a rate of 25% three times over: when it is sold to the processor; when the processor sells it to the retailer; and when the retailer sells it to the consumer. In Massachusetts, Nevada and Oregon, medical cannabis shops will be permitted to open this year. In the Netherlands, although the sale of cannabis is still illegal, ‘coffee shops’ are permitted to sell people up to 5 grams per day.
So should cannabis be legalised? People have very strong views on the subject and this can make a calm assessment of the issue more difficult. The economist’s approach to legalising cannabis involves seeking to identify and measure the costs and benefits of doing so. If the benefits exceed the costs, then it should be legalised; if not, it should remain illegal (or made illegal). The problem is that the size of the costs and benefits are not easy calculate as they involve estimates of things such as consumption levels, tax revenues, crime reduction, the effects on the consumption of other drugs, including legal drugs such as alcohol and tobacco.
Nevertheless, various estimates of these costs and benefits have been made and provide a basis for discussion.
Possible benefits of cannabis legalisation include: increased tax revenues for the government; reduction in crime, and hence reduction in law enforcement and prison costs; encouraging people with addiction problems to seek help, as they would not fear arrest; reduction in the price, benefiting users; regulating quality of the drug; reducing the consumption of alcohol and more dangerous drugs if these are substitutes for cannabis; moral arguments concerning freedom of individuals to choose their lifestyle.
Possible costs include: increased consumption of cannabis, with attendant health and social side effects; increased consumption of other drugs if they are complements, or if cannabis is an ‘entry level’ drug to harder drugs; moral objections to drug taking.
Clearly some of these costs and benefits are easier to measure than others. Moral arguments are almost impossible to assess quantitatively, even when various underlying moral standpoints are agreed.
The following articles look at recent events and at the arguments, both economic and non-economic.
Articles
As Uruguay moves to legalise cannabis, is the ‘war on drugs’ finished? Metro (20/1/14)
Regulating the sale of marijuana: Global perspective Journalist’s Resource, John Wihbey (17/1/14)
Next Step in Uruguay: Competitive, Quality Marijuana Independent European Daily Express (IEDE) (12/1/14)
U.S. support for legalization of marijuana at an all-time HIGH Mail Online, Anna Edwards (7/1/14)
14 Ways Marijuana Legalization Could Boost The Economy Huffington Post, Harry Bradford (7/11/12)
Colorado pot legalization: 30 questions (and answers) The Denver Post, John Ingold (13/12/12)
Economists Predict Marijuana Legalization Will Produce ‘Public-Health Benefits’ Forbes, Jacob Sullum (1/11/13)
Papers
Economics of Cannabis Legalization Hemp Today, Dale Gieringer (10/10/93)
Pros & Cons of Legalizing Marijuana About.com: US Liberal Politics, Deborah White
Would Marijuana Legalization Increase the Demand for Marijuana? About.com: Economics, Mike Moffatt
Time to Legalize Marijuana? – 500+ Economists Endorse Marijuana Legalization About.com: Economics, Mike Moffatt
A cost benefit analysis of cannabis legalisation Institute for Social and Economic Research, University of Essex
Licensing and regulation of the cannabis market in England and Wales: Towards a cost–benefit analysis Institute for Social and Economic Research, University of Essex, Mark Bryan, Emilia Del Bono and Stephen Pudney (9/13)
What Can We Learn from the Dutch Cannabis Coffeeshop Experience? Rand Drug Policy Research Center, Robert J. MacCoun (7/10)
Podcast
Licensing and regulating the cannabis market in England and Wales Institute for Social and Economic Research, University of Essex, Stephen Pudney (15/9/13)
Questions
- If a country legalises cannabis, what is likely to happen to the price of cannabis? Use a demand and supply diagram to illustrate your argument, considering the effects on both demand and supply. How are the price elasticities of demand and supply relevant to your answer?
- What externalities are there from drug use?
- What externalities are there from making cannabis illegal?
- Distinguish between complementary and substitute goods for cannabis? How is the demand for these likely to be affected by legalising cannabis?
- Go through each of the benefits and costs of legalising cannabis and identify difficulties that might be experienced in quantifying these costs and benefits?
- If cannabis were legalised, how would you set about determining the optimum rate of tax on cannabis production, processing, distribution and sale?
- Consider the arguments for and against legalising cannabis from the perspective of (a) a free-market liberal and (b) a social democrat who sees government intervention as an important means of achieving various social goals.
In an apparent U-turn, the Chancellor, George Osborne, has decided to cap the interest rates and other charges on payday loans and other short-term credit. As we have seen in previous news items, the sky-high interest rates which some of the poorest people in the UK are being forced to pay on these loans have caused outrage in many quarters: see A payday enquiry and Kostas Economides and the Archbishop of Canterbury. Indeed, the payday loan industry has been referred by the OFT to the Competition Commission (CC). The CC is required to report by 26 June 2015, although it will aim to complete the investigation in a shorter period.
It was becoming increasingly clear, however, that the government would not wait until the CC reports. It has been under intense pressure to take action. But the announcement on 25 November 2013 that the government would cap the costs of payday loans took many people by surprise. In fact, the new body, the Financial Conduct Authority, which is due to start regulating the industry in April 2014, only a month ago said that capping was very intrusive, arguing that it could make it harder for many people to borrow and push them into the hands of loan sharks. According to paragraph 6.71 of its consultation paper, Detailed proposals for the FCA regime for consumer credit:
The benefits of a total cost of credit cap has been looked at by the Personal Finance Research Centre at the University of Bristol. This report highlighted that 17 EU member states have some form of price restriction. Their research was ambiguous, on the one hand suggesting possible improved lending criteria and risk assessments. On the other, prices may drift towards a cap, which could lead to prices increasing or lead to a significant reduction in lenders exercising forbearance. Neither of these latter outcomes would be beneficial for consumers. Clearly this is a very intrusive proposition and to ensure we fully understand the implications we have committed to undertake further research once we begin regulating credit firms and therefore have access to regulatory data.
The government announcement has raised questions of how imperfections in markets should be dealt with. Many on the centre right argue that price controls should not be used as they can further distort the market. 
Indeed, the Chancellor has criticised the Labour Party’s proposal to freeze gas and electricity prices for 20 months if it wins the next election, arguing that the energy companies will simply get around the freeze by substantially raising their prices before and after the 20 months.
Instead, those on the centre right argue that intervention should aim to make markets more competitive. In other words, you should attempt not to replace markets, but to make them work better.
So what is the reasoning of the government in capping payday loan charges? Does it feel that, in this case, there is no other way? Or is the reasoning political? Does it feel that this is the most electorally advantageous way of answering the critics of the payday loan industry?
Webcasts and podcasts
Payday Loans To Be Capped By Government Sky News (25/11/13)
New law to cap cost of payday loans BBC News, Robert Hall (25/11/13)
Osborne: ‘Overall cost’ of payday loans to be capped BBC Today Programme (25/11/13)
George Osborne announces cap on payday loan charges amid concerns ITV News (25/11/13)
Articles
UK to cap payday lenders’ interest charges Reuters, Steve Slater, Paul Sandle, Kate Holton and William James (25/11/13)
Capping payday loans: from light touch to strong arm Channel 4 News, Faisal Islam (25/11/13)
Payday loans: New law to cap costs BBC News (25/11/13)
Payday loan ‘risk to mortgage applications’ BBC News (26/11/13)
Q&A: Payday loans BBC News (25/11/13)
George Osborne is playing social democratic catch-up on payday loans The Guardian, Larry Elliott (25/11/13_
Payday loans cap: George Osborne caves in following intervention led by Archbishop of Canterbury Independent, Oliver Wright (25/11/13)
The principle, the practice and the politics of fixing payday loan prices: why? And why now? Conservative Home, Mark Wallace (25/11/13)
George Osborne and the risky politics of chutzpah New Statesman, Rafael Behr (26/11/13)
Chancellor too quick off the mark on payday lending cap The Telegraph, James Quinn (25/11/13)
Crap and courage of convictions: the political problem with Osborne’s payday loan plan Spectator, Isabel Hardman (26/11/13)
Payday loan calculator
Payday loan calculator: how monthly interest can spiral BBC Consumer (7/11/13)
Questions
- What types of market failing exist in the payday loan industry?
- What types of controls of the industry are being proposed by George Osborne?
- What is the experience of Australia in introducing such controls?
- What alternative forms of intervention could be used to tackle the market imperfections in the industry?
- What were the proposals of the FCA? (See paragraph 6.6 in its document, Detailed proposals for the FCA regime for consumer credit.)
- According to a representative example on Wonga’s website, a loan of £150 for 18 days would result in charges of £33.49 (interest of £27.99 and a fee of £5.50). This would equate to an annual APR of 5853%. Explain how this APR is calculated.
- The proposal is to allow a relatively large upfront fee and to cap interest rates at a relatively low level, such as 4% per month, as is the case in Australia. Explain the following comment about this in the Faisal Islam article above: “The upfront fee, in theory, should change the behavioural finance of consumers around taking the loan in the first place (there are ways around this though). So this is an intervention based not on lack of competition, but asymmetries of information in consumer finance.”
- Comment on the following statement by Mark Wallace in the Conservative Home article above: “If overpriced payday loans should be capped, why not overpriced DVDs, sandwiches or, er, energy bills?”
- Compare the relative advantages and disadvantages of George Osborne’s proposal with that of Justin Welby, the Archbishop of Canterbury (see the news item, Kostas Economides and the Archbishop of Canterbury).
In market capitalism, the stock of manufactured capital provides a flow of output. The profitability of the use of that capital depends on the cost of investing in that capital and the cost of using it, and on the flow of revenues from that capital. Discounted cash flow techniques can be used to assess the profitability of a given investment in capital; the flows of costs and revenues are discounted at a market discount rate to give a net present value (NPV). If the NPV is positive (discounted revenues exceed discounted costs), the investment is profitable; if it is negative, the investment is unprofitable. (See Economics, 8th edition, section 9.3.)
There may be market imperfections in the allocation of investment, in terms of distorted prices and interest rates. These may be the result of market power, asymmetry of information, etc., but in many cases the market allows capital investment to be allocated relatively efficiently.
Natural capital
This is not the case with ‘natural capital’. Natural capital (see also) is the stock of natural resources and ecosystems that, like manufactured capital, yields a flow of goods and services into the future. 
Natural capital, whilst it can be improved or degraded by human action, is available without investment. Thus the natural capital of the oceans yields fish, the natural capital of the skies yields rain and the natural capital of forests reduces atmospheric CO2.
Even though some natural capital is owned (e.g. private land), much is a common resource. As such, it is free to use and tends to get overused. This is the Tragedy of the Commons – see, for example, the following news items: A modern tragedy of the commons and Is there something fishy going on?.
Natural capital accounting
But would it be possible to give a value to both the stock of natural capital and the goods and services provided by it? Would this environmental accounting enable governments to tax or subsidise firms and individuals for their use or enhancement of natural capital?
On 21 and 22 November 2013, the first World Forum on Natural Capital took place in Edinburgh. This brought together business leaders, politicians, economists, environmentalists and other scientists to discuss practical ways of taking natural capital into account in decision making. Central to the forum was a discussion of ways of valuing natural capital, or ‘natural capital accounting’. As the forum site states:
Natural capital accounting is a rapidly evolving new way of thinking about how we value the economic benefits we derive from our natural environment. The World Forum on Natural Capital will bring together world-class speakers, cutting edge case studies and senior decision makers from different sectors, in order to turn the debate into practical action.
But if natural capital is not owned, how is it to be priced? How will the costs and benefits of its use be valued? How will inter-generational effects be taken into account? Will firms price natural capital voluntarily if doing so reduces their profits? Will firms willingly extend corporate social responsibility to include corporate environmental responsibility? Will governments be prepared to introduce taxes and subsidies to internalise the costs of using natural capital, even if the effects extend beyond a country’s borders? Will natural capital accounting measure purely the effects on humans or will broader questions of maintaining and protecting environmental diversity for its own sake be taken into account? These are big questions and ones that various organisations are beginning to address.
Despite problems of measurement and incentives, sometimes there are clear economic benefits from careful evaluation and management of natural capital. Julia Marton-Lefèvre is Director General of the International Union for Conservation of Nature (IUCN). According to the first Guardian article below:
Her favourite example of natural capital working in practice comes from Vietnam, where “planting and protecting nearly 12,000 hectares of mangroves cost just more than $1m but saved annual expenditures on dyke maintenance of well over $7m. And that only accounts for coast maintenance: mangroves are also nurseries for fish, meaning livelihoods for fishing and source of nutrients … “
One organisation attempting to value natural capital is The Economics of Ecosystems and Biodiversity project (TEEB). It also looks at what organisational changes are likely to be necessary for the management of natural capital.
Based on data collected from 26 early adopter companies (60% of them with $10 Billion+ revenues each) across several industry sectors this provides real life evidence on the drivers and barriers for natural capital management.
Pricing the environment is a highly controversial issue. Critics claim that the process can easily be manipulated to serve the short-term interests of business and governments. What is more, where tradable permits markets have been set up, such as the EU’s Emissions Trading Scheme (ETS), prices have often been a poor reflection of social costs and have been open to manipulation. As Nick Dearden, director of the World Development Movement (WDM), says:
It is deeply ironic that the same financial markets that caused the economic crisis are now seen as the solution to our environmental crisis. It’s about time we learnt that financial markets need to be reined in, not expanded. Pricing these common resources on which people depend for their survival leaves all of us more exposed to the forces of the global economy, and decisions about whether or not to protect them become a matter of accounting.
The measurement of natural capital and setting up systems to internalise the costs and benefits of using natural capital is both complex and a political minefield – as the following articles show.
Articles
Putting a value on nature: Edinburgh conference says business is ‘part of the solution’ Blue & Green Tomorrow, Nicky Stubbs (20/11/13)
Edinburgh forum says putting value on nature could save it BBC News, Claire Marshall (20/11/13)
Natural capital must be the way forward, says IUCN director general The Guardian, Tim Smedley (11/11/13)
Is ‘natural capital’ the next generation of corporate social responsibility? The Guardian, Tim Smedley (7/11/13)
Natural capital accounting: what’s all the fuss about? The Guardian, Alan McGill (27/9/13)
Put nature at the heart of economic and social policymaking The Guardian, Aniol Esteban (1/3/13)
Campaigners warn of dangers of ‘privatised nature’ The Scotsman, Ilona Amos (21/11/13)
Edinburgh conference attempts to ‘privatise nature’ World Development Movement, Miriam Ross (18/11/13)
Valuing Nature BBC Shared Planet, Monty Don (8/7/13)
Sites concerned with natural capital
World Forum on Natural Capital
TEEB for Business Coalition
International Union for Conservation of Nature
Questions
- How would you define natural capital?
- What are ecosystem services?
- Is social efficiency the best criterion for evaluating the use of the environment? What other criteria could you use?
- How would you set about deciding what rate of discount to use when evaluating the depletion of or enhancement of natural capital?
- How can game theory provide insights into the strategies of both businesses and governments towards the environment?
- What are the arguments for and against attempting to value natural capital and to incorporate these values in decision making?
As Elizabeth noted in Fuelling the Political Playing Field, there has been much debate recently about energy prices in the UK. Four of the ‘Big Six’ energy companies have now announced price rises. They average 9.1% – way above the rate of consumer price inflation and even further above the average rate of wage increases. What is more, they are considerably above the rate of increase in wholesale energy prices, which, according to Ofgem, have risen by just 1.7% in the past year.
The bosses of the energy companies have appeared before the House of Commons Energy and Climate Change Select Committee to answer for their large price increases. The energy companies claim that the increases are necessary to cover not only rising wholesale prices, but also green levies by the government and ‘network charges’ for investments in infrastructure. 
However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.
Another possible explanation for the price hikes is that they are partly the result of a system of transfer pricing (see). The energy industry is vertically integrated. Energy companies are not only retailers to customers, but also generators of electricity and wholesale shippers of gas. It is possible that, by the producing/shipping arms of these companies charging higher prices to their retailing arms, the retailers’ costs do indeed go up more than the wholesale market cost. The result, however, is higher profits for the producing arms of these businesses. In other words, a higher transfer price allows profits to be diverted from each company’s retailing arm to its producing arm.
This is an argument for making the wholesale market more competitive and for stopping the by-passing of this market by producing arms of companies selling directly to their retailing arms. What the companies are being accused of is an abuse of market power and possibly of colluding with each other, at least tacitly, to support the continuation of such a practice.
So is the answer a price freeze, as proposed by the Labour Party? Is it an investigation of the energy market by the Competition Commission? Or is it, at least as a first step, much more openness by the energy companies and transparency about their pricing practices? Or is it to encourage consumers to switch between energy companies, including the smaller ones, which at present account for less than 5% of energy supply? The videos, podcasts and articles consider these issues.
Webcasts and Podcasts
Energy bosses blame high bills on wholesale prices Channel 4 News, Gary Gibbon (29/10/13)
Why are energy bosses being questioned? BBC News, Stephanie McGovern (29/10/13)
Key questions Big Six energy companies must answer The Telegraph, Ann Robinson (29/10/13)
Energy bosses offer excuses for prices rises The Telegraph (29/10/13)
Energy bosses face MPs over price rises BBC News, John Moylan (29/10/13)
Energy boss ‘can’t explain’ competitors’ price hikes The Telegraph (29/10/13)
Ovo boss: Competition Commission would take too long BBC News (30/10/13)
Dale Vince: Energy market is ‘dysfunctional’ BBC Today Programme (30/10/13)
Tony Cocker: Public mistrust energy industry BBC Today Programme (30/10/13)
Ed Davey: Energy deals not just for ‘internet savvy’ BBC Today Programme (31/10/13)
Articles
Energy giants ‘charge as much as they can get away with’ The Telegraph, Peter Dominiczak (29/10/13)
UK energy markets need perestroika Financial Times (27/10/13)
Britain’s energy utilities must embrace glasnost Reuters, John Kemp (29/10/13)
Small energy firms ‘escape levies’ BBC News (30/10/13)
Is the energy market structurally flawed? BBC news, Robert Peston (30/10/13)
The energy market needs a Competition Commission investigation Fingleton Associates, John Fingleton (12/10/13)
Energy firms raised prices despite drop in wholesale costs The Guardian, Rowena Mason (29/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (26/10/13)
Energy Giants Blame Rising Bills On Green ‘Stealth Taxes’ Huffington Post, Asa Bennett (29/10/13)
Big Six energy firms ‘like cartel’ Belfast Telegraph (30/10/13)
Energy boss says he hasn’t done sums on green levies The Telegraph, Georgia Graham (30/10/13)
Graphic: How your energy bills have soared in ten years The Telegraph, Matthew Holehouse (30/10/13)
British energy suppliers’ explanations for price hikes just don’t add up The Guardian, Larry Elliott (31/10/13)
The 18th energy market investigation since 2001: Will this one be different? The Carbon Brief, Ros Donald (31/10/13)
Energy: Is there enough competition in the market? BBC News, Hugh Pym (26/11/13)
Information and Reports
Wholesale [electricity] market Ofgem
Wholesale [gas] market Ofgem
Response on wholesale energy costs Ofgem Press Release (29/10/13)
Response to Government’s Annual Energy Statement Ofgem Press Release (31/10/13)
Real Energy Market Reform The Labour Party
Questions
- Why may the costs of energy paid by the energy retailers to energy producers/shippers have risen more than the wholesale price?
- Explain what is meant by transfer pricing. How could transfer pricing be used to divert profits between the different divisions of a business?
- How can transfer pricing be designed by multinational companies to help them minimise their tax bills?
- Why is policing transfer pricing arrangements notoriously difficult?
- What evidence is there to show that switching between retailers by customers can help to drive retail energy prices down?
- How did the old electricity pool system differ from the current wholesale system?
- Should electricity companies be forced to pool the electricity they generate and not sell it to themselves through bilateral deals?
- Comment on the following: “The current electricity trading arrangements ‘create the very special incentive for the oligopolists. …The best of all possible worlds is where nobody invests. As supply and demand close up, the price spikes upwards, and supernormal profits result.'”
