It occurred to me recently that the economic system does not really produce anything. From our individual perspective it appears that many goods and services are produced... but what then? Adam Smith famously said that 'consumption is the sole end and purpose of all production', so everything we produce is subsequently consumed, leaving us with...?
We might think that this makes no sense. We produce goods to consume them - that is the purpose and the point. But what happens then? We consume goods and services and then we supply our labour to produce more goods and services, which are ultimately consumed and so one and so forth.
The economist would say that we produce utility. That is, some kind of happiness or satisfaction in each of us from the act of consumption. But much research suggests that happiness is determined internally once some basic human needs are met. So if all this production and consumption is not producing happiness, what is it producing?
From a physical perspective, some ecological economists have suggested that all the functions within an economy are interdependent. We think the production as a one-way street, but the consumption of food, housing and entertainment is necessary for the supply of labour, which goes back into production. It could be imagined that there is no real production in the economy. It is simply a system that enables humans to fulfil their basic biological desire to reproduce and support a growing population. We could then say the economy produces people, but that again would be arbitrarily confining the system, since as suggested earlier, people are a functional part of the whole.
Maybe this is a strange way to view the world. A system without purpose that produces nothing. But in fact, Darwin would suggest that is a good way to describe it. That is how he described biological systems - a system based on variation, inheritance and selection, with no forethought or purpose. We are just animals after all.
Anyway, for those out there who like to blame the political, economic or banking system for the world's ills, and think there must be some alternative, relax. There isn't. Many of the world's problems, from poverty and human rights issues, to environmental issues stem not from our institutional systems, but from greater biological evolutionary systems that blindly created humanity in the first place. Any political or economic system will suffer the same fate.
So please relax and enjoy yourself - because happiness comes from within.
Wednesday, July 16, 2008
Tuesday, July 15, 2008
Amory Lovins - a crackpot with a mo!
The world media is full of optimistic talk of a future hydrogen economy and soft energy paths courtesy of Amory Lovins. Most famously he coined the term 'negawatts' to describes energy savings from energy efficient gizmos. For some reason, otherwise intelligent people have jumped on board the scam train and preached that the best thing we can all do is use energy more efficiently, and there will be not need for more energy generation capacity.
Rather than waste more time, I will bluntly show the absurdity of this claim. I currently eat one banana a day, but could eat them more efficiently, resulting in me eating just one per week! Each week I am now producing 6 negabananas! Surely there is no reason to clear the forest for banana planations since we can all consume them more efficiently! Lovins however takes the whole 'negascam' thing even further. He says that consumers should be paid to produce negawatts. Seriously, I produce an thousands of negawatts - I could plug in flood lights into all the electricity sockets in my home, using thousands of real megawatts (hours that is) but I don't. Therefore, I am instead producing thousand of negawatts. Where is me cheque?
The reality is our global economic system requires energy, and for the system to grow, we either need more people, or more energy available per person. It is a simple as that. Our choices are to continue using more energy each year and maintain growth, or use less energy and have negative growth.
Rather than waste more time, I will bluntly show the absurdity of this claim. I currently eat one banana a day, but could eat them more efficiently, resulting in me eating just one per week! Each week I am now producing 6 negabananas! Surely there is no reason to clear the forest for banana planations since we can all consume them more efficiently! Lovins however takes the whole 'negascam' thing even further. He says that consumers should be paid to produce negawatts. Seriously, I produce an thousands of negawatts - I could plug in flood lights into all the electricity sockets in my home, using thousands of real megawatts (hours that is) but I don't. Therefore, I am instead producing thousand of negawatts. Where is me cheque?
The reality is our global economic system requires energy, and for the system to grow, we either need more people, or more energy available per person. It is a simple as that. Our choices are to continue using more energy each year and maintain growth, or use less energy and have negative growth.
Monday, July 14, 2008
My list of problems with economics
1. That most theories are base on some equilibrium position. Ceteris paribus, the world should converge to this point. However, this clearly has not happened, and is not likely to in the future. So what value are these equilibrium models?
Wouldn’t a better way be to explain the processes that cause constant changes? Rather than observing given situations, would it be better to know the processes that create the situations from previous ones? This is where evolutionary explanations come into play. The theory of evolution describes how such causal processes behave. An understanding of these processes may bring a whole new foundation to economics – where rather than focus on determining absolute outcomes, we focus on determining absolute processes, which, when given current starting points, will determine future paths.
2. Macro economics for the most part does not know what it is measuring, and therefore, cannot be much use in explaining our world. What are real incomes? What is the ‘price level’, when the type of goods in the economy continually change? If there is a price level, what is it relative to? Why is unemployment a bad thing when government benefits are provided? Do we value our time so poorly, and money so highly? Furthermore, there is a distinct lack of causal explanation for many of the phenomena observed. One observation of and abstract construct correlates with another observation of an abstract construct. Neither of which are known to the agents who make the decisions.
3. The great illusion of technology. Economists use the term ‘technology’ to explain everything the cannot explain. In the Solow growth model, technology is simply a residual term that captures everything that is not labour and capital. Can we really be so ignorant about the process of economic growth? Also, environmentalist have got the whole process backwards with regard to technological improvements in resource efficiency. Historically we know that such improvements cause increased resource consumption – how can they all of sudden start doing the opposite?
I’m sure there are many more, but that should be enough for today.
Wouldn’t a better way be to explain the processes that cause constant changes? Rather than observing given situations, would it be better to know the processes that create the situations from previous ones? This is where evolutionary explanations come into play. The theory of evolution describes how such causal processes behave. An understanding of these processes may bring a whole new foundation to economics – where rather than focus on determining absolute outcomes, we focus on determining absolute processes, which, when given current starting points, will determine future paths.
2. Macro economics for the most part does not know what it is measuring, and therefore, cannot be much use in explaining our world. What are real incomes? What is the ‘price level’, when the type of goods in the economy continually change? If there is a price level, what is it relative to? Why is unemployment a bad thing when government benefits are provided? Do we value our time so poorly, and money so highly? Furthermore, there is a distinct lack of causal explanation for many of the phenomena observed. One observation of and abstract construct correlates with another observation of an abstract construct. Neither of which are known to the agents who make the decisions.
3. The great illusion of technology. Economists use the term ‘technology’ to explain everything the cannot explain. In the Solow growth model, technology is simply a residual term that captures everything that is not labour and capital. Can we really be so ignorant about the process of economic growth? Also, environmentalist have got the whole process backwards with regard to technological improvements in resource efficiency. Historically we know that such improvements cause increased resource consumption – how can they all of sudden start doing the opposite?
I’m sure there are many more, but that should be enough for today.
Sunday, July 13, 2008
Sustainability is not about small actions – it is about human nature
Imagine you work as a reporter for a newspaper. due to your extreme environmental concern you decide that if you didn’t write your articles every day, then the paper they are printed on would be saved. As a compromise, you make sure to halve the length of each article. Further, if just one reporter from each newspaper around the world would take such actions, you imagine that many thousands of tonnes of paper would be saved.
Such a scenario describes the thinking of most conservationists, but it is fundamentally flawed. For starters, the newspaper must fill each page with something, so it may very well choose to fill the space with advertising or some other extended articles. Also, the publisher will seek to expand circulation, which itself requires more paper. Your actions have achieved nothing.
This is symbolic of the world we live. Small actions get absorbed by the economic machine, resulting in at best a substitution of resources and environmental problems. Even very large commitments will be absorbed by other global players.
The machine is not the ‘economic system’ the banking system or any other human construct. It is humanity. We are animals with inbuilt desire to reproduce. We seek out ranking above others to increase our reproductive chances, and we seek innovative ways of increasing the productivity of our labour time. To make any real environmental improvement means changing humanity. Or we simply wait till our rapid species explosion is brought into balance by our environment, and start all over again. It is not pretty, but that is sustainable. Repeated waves of human population expansion, fuelled by genetic desire for reproduction and rank.
Some have argued that we can create cultural forces that override these genetic desires, such that seeking rank and productive innovation are frowned upon. This may be the case. The luddites live in a similar fashion. But it takes only one ‘bad egg’ to come to power to stimulate these desires once again.
This is my thought of the day
Such a scenario describes the thinking of most conservationists, but it is fundamentally flawed. For starters, the newspaper must fill each page with something, so it may very well choose to fill the space with advertising or some other extended articles. Also, the publisher will seek to expand circulation, which itself requires more paper. Your actions have achieved nothing.
This is symbolic of the world we live. Small actions get absorbed by the economic machine, resulting in at best a substitution of resources and environmental problems. Even very large commitments will be absorbed by other global players.
The machine is not the ‘economic system’ the banking system or any other human construct. It is humanity. We are animals with inbuilt desire to reproduce. We seek out ranking above others to increase our reproductive chances, and we seek innovative ways of increasing the productivity of our labour time. To make any real environmental improvement means changing humanity. Or we simply wait till our rapid species explosion is brought into balance by our environment, and start all over again. It is not pretty, but that is sustainable. Repeated waves of human population expansion, fuelled by genetic desire for reproduction and rank.
Some have argued that we can create cultural forces that override these genetic desires, such that seeking rank and productive innovation are frowned upon. This may be the case. The luddites live in a similar fashion. But it takes only one ‘bad egg’ to come to power to stimulate these desires once again.
This is my thought of the day
Vegetarianism and the environment – a different angle
“It takes soo much less land to produce a calorie of energy from vegetables than from meat. If only we all ate less meat we could free up so much land from farming.”
This type of message is heard quite often, especially around my suburb, which is renowned form its high concentration of hippies. But on what basis are such claims made?
There is no debate that less land is required for a vegetarian diet than an omnivorous one. The debate centres on whether widely adopting vegetarianism is likely to result in an improved environment.
Let us meander through a thought experiment. Imagine the world today, and the present diet of the people, and then imagine that in one day 95% of people decide to become vegetarian. Meat industries of the world collapse while grain and vegetable farming expands rapidly. At this point the world is fed on the new diet, and some land previously used for grazing is now vacant. This is the utopia envisioned in the quote above, but what happens next?
The world does not stand still, that is for sure. There are many flow-on effects. The typical diet will now be cheaper, allowing money to be spent elsewhere. Not only will this consumption have environmental impacts of its own, but the increased level of wealth will allow a population increase. Such a rise in population will result from increased life expectancy afforded by increased wealth. More people will also require more resources. The likelihood of such effects offsetting the reduction in land used for meat production on the net environmental condition of the globe is uncertain.
What is certain is that such a narrow justification for individual actions to reduce environmental pressure is misleading, and can often suggest the opposite result from the true eventuality.
This type of message is heard quite often, especially around my suburb, which is renowned form its high concentration of hippies. But on what basis are such claims made?
There is no debate that less land is required for a vegetarian diet than an omnivorous one. The debate centres on whether widely adopting vegetarianism is likely to result in an improved environment.
Let us meander through a thought experiment. Imagine the world today, and the present diet of the people, and then imagine that in one day 95% of people decide to become vegetarian. Meat industries of the world collapse while grain and vegetable farming expands rapidly. At this point the world is fed on the new diet, and some land previously used for grazing is now vacant. This is the utopia envisioned in the quote above, but what happens next?
The world does not stand still, that is for sure. There are many flow-on effects. The typical diet will now be cheaper, allowing money to be spent elsewhere. Not only will this consumption have environmental impacts of its own, but the increased level of wealth will allow a population increase. Such a rise in population will result from increased life expectancy afforded by increased wealth. More people will also require more resources. The likelihood of such effects offsetting the reduction in land used for meat production on the net environmental condition of the globe is uncertain.
What is certain is that such a narrow justification for individual actions to reduce environmental pressure is misleading, and can often suggest the opposite result from the true eventuality.
Friday, July 11, 2008
Myths of demand side management
Some of you may have noticed businesses offering to install new efficiency light bulbs in your house for free. One example is envirocare.com. A lovely lady asked me at the local shopping centre lately whether I had heard about such opportunities. I had not. I took the brochure and continued my enquiries online. It seems that to be able to offer such amazing deals to residents, the company is actually producing greenhouse gas abatement certificates through these measures which they sell to other business to offset their own emissions. Such a system is based on principles of demand side management. But does this system have sound foundations?
A short story may highlight some flaws of this program. Joe is on a budget, and is known as the guy who is careful not to waste anything. He always turns the lights out when not in a room, and always switches off appliances. The offer of free efficient lighting seems irresistible. He arranges to have his all his light bulbs replaced by Envirocare. Now, that lighting costs him only one fifth of the price it used to, he leaves a light on out the front when he goes out and is much less concerned about turning lights around them home. Since he is now saving so much on electricity, he buys a bigger television, which he leaves on most of the day, and small bar fridge to make space for his beer. A year after the new light bulbs Joe’s electricity consumption is twenty percent higher than before. Where is the energy saving for which supports these abatement certificates?
The short answer is there is no energy saving in this story. If not for the reduction in electricity costs Joe would not have been able to expand his consumption to the new television and bar fridge. More precisely, there is a direct causal link from the efficient lighting and the increased electricity consumption. In this story, greenhouse gas abatement certificates have been created from nothing!
Demand side management is fundamentally flawed. It relies on the assumption that demand for electricity will remain fixed even when prices change. This assumption is false. When the price of lighting is reduced, demand for it will rise – Joe’s did. Also, as incomes rise demand for energy rises. Neither of these issues are considered relevant by demand side advocates, yet there is growing evidence that it is just as effective as doing nothing.
So where does this leave us? Is doing nothing an option? If doing nothing is better than doing something why can’t that be a conscious choice?
Personally, the I feel that clear relief is coming. Remaining reserves of oil and coal are depleting, and in due course, the rising costs of these energy sources will result in reductions in energy consumption. But it won’t be a pleasant and productive period. It will result in radical economic slowdown – there is simply no alternative.
A short story may highlight some flaws of this program. Joe is on a budget, and is known as the guy who is careful not to waste anything. He always turns the lights out when not in a room, and always switches off appliances. The offer of free efficient lighting seems irresistible. He arranges to have his all his light bulbs replaced by Envirocare. Now, that lighting costs him only one fifth of the price it used to, he leaves a light on out the front when he goes out and is much less concerned about turning lights around them home. Since he is now saving so much on electricity, he buys a bigger television, which he leaves on most of the day, and small bar fridge to make space for his beer. A year after the new light bulbs Joe’s electricity consumption is twenty percent higher than before. Where is the energy saving for which supports these abatement certificates?
The short answer is there is no energy saving in this story. If not for the reduction in electricity costs Joe would not have been able to expand his consumption to the new television and bar fridge. More precisely, there is a direct causal link from the efficient lighting and the increased electricity consumption. In this story, greenhouse gas abatement certificates have been created from nothing!
Demand side management is fundamentally flawed. It relies on the assumption that demand for electricity will remain fixed even when prices change. This assumption is false. When the price of lighting is reduced, demand for it will rise – Joe’s did. Also, as incomes rise demand for energy rises. Neither of these issues are considered relevant by demand side advocates, yet there is growing evidence that it is just as effective as doing nothing.
So where does this leave us? Is doing nothing an option? If doing nothing is better than doing something why can’t that be a conscious choice?
Personally, the I feel that clear relief is coming. Remaining reserves of oil and coal are depleting, and in due course, the rising costs of these energy sources will result in reductions in energy consumption. But it won’t be a pleasant and productive period. It will result in radical economic slowdown – there is simply no alternative.
Wednesday, January 2, 2008
Growth spurt draining the state dry
Cyclone Odette may have been the last chance to receive drenching rain to top up the parched dams of the southeast corner before the winter, and it passed by leaving just a few drops.
In the same week, the Federal Government announced it will fund the long-awaited $2.3 billion Goodna bypass, and yesterday I received a rebate from the State Government for installing a water tank.
The connection between these three events is water, and more specifically, the lack of this precious resource in the dams around southeast Queensland. As we enter our dry season under the imposition of level 5 water restrictions, residents are being expected to cut their domestic water use to a scarce minimum. To offer further incentive, the state and local governments are offering grants to install water tanks for residential buildings. But if the State Government and Brisbane City Council were truly serious about the issue, and serious about the long-term sustainability of the region, why are they now spending many billions on large infrastructure projects designed to encourage rapid development?
The connection between the water crisis and the rapid scale of development in Queensland is clear to many people. Not only do more people need more water, but the development of new homes, workplaces and infrastructure requires massive amounts of water before and during construction.
The water required in the production of goods is known as embodied water, and has been overlooked in the decision-making processes for development in the southeast corner. In construction projects, the volumes of embodied water are extremely high. Recent studies from Deakin University show that the embodied water of a three storey office building designed to high environmental standards is about 54,100 litres per square metre of space. This is the equivalent of 18 3000 litre domestic water tanks, six months' domestic consumption by one person, or enough drinking water for one person for 37 years.
In the Brisbane CBD alone there is an estimated 100,000sqm of office space expected to be constructed this year, which would use about 5.4 billion litres of our supply – almost equal to the domestic consumption of Bundaberg with a few million litres to spare.
To offer some ballpark figures on embodied water, the CSIRO has found there is about 140 litres of embodied water for every dollar's worth of steel, and 15 litres for every dollar's worth of concrete. Other less reliable evidence suggests there is in the order of 40 litres of embodied water per dollar spent on construction.
Based on these figures, one might wonder how much water is going to be required to build Campbell Newman's TransApex plan. The North-South Bypass Tunnel alone will use 280,000 cubic metres of concrete and cost in the order of $3 billion (or will it cost us 120 billion litres of water?)
And what about the other infrastructure projects which have been proposed, such as the Goodna Bypass, or those under construction?
Putting enormous pressure on residents to save every drop seems ludicrous among this wastefulness. Even if every person in Brisbane saved 10 litres per day this year, it would be the equivalent of about 4 percent of the embodied water of the NSBT.
If the State Government is serious about water, it must get serious about limiting the scale of development in southeast Queensland. When you find yourself in a hole, you stop digging. When you find that you have outgrown your natural resources, you stop growing.
First Home Owners Grant has driven the housing affordability crisis
There has been much publicity recently about Australia’s growing housing affordability crisis. And quite justifiably. The 3rd Annual Demographia International Housing Affordability Survey released earlier this year puts Sydney, Hobart, Perth and Melbourne in the 25 least affordable housing markets in a study of Australia, New Zealand, United Kingdom, Republic of Ireland, United States and Canada. Shocking research such as this study has put pressure on the Federal Government to relieve pressure through tax reforms and incentives.
Young Liberal Micheal Janda, in an award winning essay, proposed that the First Home Owners Grant was a positive move to combat unaffordability, yet this has simply not been the case.
The FHOG was intended to assist first home buyers to offset the impact of the introduction of the goods and services tax (GST). Apart from the obvious indirect relationship that GST and home buying have (since residential dwellings are GST exempt) and that the GST had impacts on all people, not just potential first home buyers, there is startlingly clear evidence to suggest that the FHOG was the stimulus for a reduction in affordability since 2000.
From the 1st July 2000, home buyers who had not previously owned their own property were given $7,000 by the federal government. Immediately, the price of housing in all areas would rise by at least this amount, for a first home buyer could offer for example $5,000 more for a property and still be $2,000 better off than another buyer.
The FHOG was intended to assist first home buyers to offset the impact of the introduction of the goods and services tax (GST). Apart from the obvious indirect relationship that GST and home buying have (since residential dwellings are GST exempt) and that the GST had impacts on all people, not just potential first home buyers, there is startlingly clear evidence to suggest that the FHOG was the stimulus for a reduction in affordability since 2000.
From the 1st July 2000, home buyers who had not previously owned their own property were given $7,000 by the federal government. Immediately, the price of housing in all areas would rise by at least this amount, for a first home buyer could offer for example $5,000 more for a property and still be $2,000 better off than another buyer.
In an instant, prices all residential markets rose by $7,000.
Not only were the buyers who were already in a position to buy now helped along, but those who could not have been in the market except for the grant had started buying. This lead to an increase in potential buyers in any given area, thus an increase in aggregate demand for residential property, and following basic economic principles, an increase in prices. So not only were prices increased by $7,000, but also the flow on effects of a larger pool of buyers lead to further rises. Of course, looking at other flow on effects, or transformational effects, it could be stated that this rise in prices stimulated even more speculative investment, thus leading to a positive feedback cycle where as prices are seen to rise, more investment is made, raising prices even further. In property terminology this would be labelled a boom.
Addressing housing affordability is not a simple task, and like many other crisis, there is no silver bullet. Solutions will need logical foundations and sufficient time to wind back the crisis without causing other new crises. The call from the property development lobby to rezone more land for development is another counter-productive suggestion. There is already surplus land with development potential. But developers must wait for prices to rise before they can develop it. Can you imagine a property developer moving in to an area and selling below current market prices to forse the market down? It will not happen.
One of the best suggestions to address this crisis is a gradual movement of tax subsidies away from investment property to owner occupied dwellings. Currently, all maintenance expenses, interest on loans, and depreciation are all tax deductible for investment property. For your own home, you get nothing except a tax break on capital gains tax if you sell.
For a home purchased for $400,000, the tax benefits to the investment buyer over the home owner could easily exceed $15,000 dollar per year. The comprises of tax deductible interest and depreciation of the building, as well as rates and insurance costs. It makes the FHOG look like a token gesture.
Let’s get serious about the issue, and get people into their own homes. The benefits of home ownership to communities around Australia should be acknowledged and acted upon today.
Addressing housing affordability is not a simple task, and like many other crisis, there is no silver bullet. Solutions will need logical foundations and sufficient time to wind back the crisis without causing other new crises. The call from the property development lobby to rezone more land for development is another counter-productive suggestion. There is already surplus land with development potential. But developers must wait for prices to rise before they can develop it. Can you imagine a property developer moving in to an area and selling below current market prices to forse the market down? It will not happen.
One of the best suggestions to address this crisis is a gradual movement of tax subsidies away from investment property to owner occupied dwellings. Currently, all maintenance expenses, interest on loans, and depreciation are all tax deductible for investment property. For your own home, you get nothing except a tax break on capital gains tax if you sell.
For a home purchased for $400,000, the tax benefits to the investment buyer over the home owner could easily exceed $15,000 dollar per year. The comprises of tax deductible interest and depreciation of the building, as well as rates and insurance costs. It makes the FHOG look like a token gesture.
Let’s get serious about the issue, and get people into their own homes. The benefits of home ownership to communities around Australia should be acknowledged and acted upon today.
Why phone and internet plans are meant to be difficult to understand
Have you ever spent the morning on the phone trying to find the best deal on a new phone line and internet plan? It seems that every company has something new and different to offer; specials package deals, bonus calls, free modem, or free installation if you sign up for the two-year contract. The options are endless.
If we measured the competitiveness of a market by the amount of customer choice, the telecommunications market would certainly have to be regarded as highly competitive. Mobile phones are perhaps even worse. With loyalty programs, free phone upgrade and phone insurance, and any number of other nifty deals to persuade customers into believing they have the best deal. In the end, it was the toss of a coin that made the decision for me. Not one of the plans, after strict comparison and scrutiny, seemed any better or worse than the others. In fact, it seemed that all the companies were offering the same product, for the same price, but packaged with any number of confusing ‘bonuses’ and ‘specials’. And there is a logical reason for this situation, which doesn’t quite fit with the Howard Governments belief that privatisation provides more efficiency through more competition.
It must first be stated that the benefits of a perfectly competitive market cannot be ignored. When there are low barriers to entry, new firms can easily enter the market to compete, and since the products are so comparable and customers have complete information, they can make the simple choice of purchasing the cheapest product offered. In this model, the cheapest, and therefore the most efficient producers become profitable, while the least efficient producers are forced out of the market. And if those who remain in the market begin to raise prices, it is easy for competing firms to enter and profit by undercutting the competition until the prices fall.
It must first be stated that the benefits of a perfectly competitive market cannot be ignored. When there are low barriers to entry, new firms can easily enter the market to compete, and since the products are so comparable and customers have complete information, they can make the simple choice of purchasing the cheapest product offered. In this model, the cheapest, and therefore the most efficient producers become profitable, while the least efficient producers are forced out of the market. And if those who remain in the market begin to raise prices, it is easy for competing firms to enter and profit by undercutting the competition until the prices fall.
Unfortunately, this theoretical market model does not actually exist in the real world. Like in physics, where a theory requires a frictionless environment, there can be no application of this theory until the limitations of the model have been addressed. And the most serious of these limitations for the perfect market are the product comparability and the complete information available to the customer.
By consciously manipulating these two criteria of a free market, all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market. This is not meant to sound like a conspiracy because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.
The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves were steadily rising.
By consciously manipulating these two criteria of a free market, all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market. This is not meant to sound like a conspiracy because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.
The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves were steadily rising.
According to economist Steven D. Levitt, this can be attributed to the realisation of a perfect market through the power of the internet. Although term life insurance policies had been quite homogeneous before this period of time, the process of shopping around for the cheapest price had been convoluted and time-consuming, whereas websites such as Quotesmith.com suddenly made the process almost instantaneous. In just a few years, the value of the term life insurance market in the US had dropped by USD$1bilion because of the new-found ease of comparability. What insurance firm would want this to happen? Even if you were a small player in the market, say a 1% market share, your turnover had just dropped by $10million. It is perhaps one of the great recent examples of the power of perfect competition in allocating resources efficiently, yet possibly one of the greatest blunders by the insurance industry.
Let us now return to the Australian telecommunications market. It is quite possible at the moment, that no two companies offer an identical phone or internet plan. The process of comparing the plans to find the best deal is currently convoluted and time-consuming (much like in the previous insurance example), and the products have been differentiated in seemingly all possible ways. Recent websites are attempting to remove this information lag and do the comparison with a double click, but may only be adding to the confusion as telecommunications providers further differentiate their products through packages and bonuses, and modify their plans more frequently in the name of incomplete information.
Imagine now if all firms in this market offered the same three identical plans - a low use package, a mid use, and a high use, all with identical call rates, fees, contracts and download quotas. What would happen to the market? Would, as in the case of term life insurance, prices plummet and leave the market with a dramatically decreased total value? If we are to believe in the ideas of Adam Smith and other advocates for more competitive markets, the answer must be an astounding yes. The real catch to this whole affair is that more competitiveness would only benefit the customers, and not the powerful and influential telecommunications firms, and not the federal government.
For the ideals of the Howard government of revenue raising through privatisation of public assets to make any sense, you must believe that in private hands, the markets will work competitively and hence benefit the customers, also know as the Australian people. But evidently, it will not.
Let us now return to the Australian telecommunications market. It is quite possible at the moment, that no two companies offer an identical phone or internet plan. The process of comparing the plans to find the best deal is currently convoluted and time-consuming (much like in the previous insurance example), and the products have been differentiated in seemingly all possible ways. Recent websites are attempting to remove this information lag and do the comparison with a double click, but may only be adding to the confusion as telecommunications providers further differentiate their products through packages and bonuses, and modify their plans more frequently in the name of incomplete information.
Imagine now if all firms in this market offered the same three identical plans - a low use package, a mid use, and a high use, all with identical call rates, fees, contracts and download quotas. What would happen to the market? Would, as in the case of term life insurance, prices plummet and leave the market with a dramatically decreased total value? If we are to believe in the ideas of Adam Smith and other advocates for more competitive markets, the answer must be an astounding yes. The real catch to this whole affair is that more competitiveness would only benefit the customers, and not the powerful and influential telecommunications firms, and not the federal government.
For the ideals of the Howard government of revenue raising through privatisation of public assets to make any sense, you must believe that in private hands, the markets will work competitively and hence benefit the customers, also know as the Australian people. But evidently, it will not.
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