EconomicsFinancial MarketsPersonal Finance

Lack of competition adds to cost of living pressures

By May 28, 2014 No Comments

Frequently the price disparity between goods purchased locally and those same goods purchased overseas is irritatingly large. Overall, Australia ranks as the fourth most expensive economy out of 177 countries measured by the price level index (PLI), according to a World Bank report [1]. It takes into account people’s purchasing power and a country’s exchange rate.

What’s behind this? At the local level, a lack of competition in banking and groceries does not appear to be helping matters.

The Herfindahl–Hirschman Index (HHI) is a measure used by economists to evaluate market concentration.

If you’re interested in the details…

The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of 30, 30, 20, and 20 percent, the HHI is 2,600 (302 + 302 + 202 + 20= 2,600).

The HHI takes into account the relative size distribution of firms in a market. It approaches zero when a market is occupied by a large number of firms of relatively equal size and reaches its maximum of 10,000 points when a market is controlled by a single firm. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.

 

The US Department of Justice [2], which acts as a competition watch-dog there, generally considers markets in which the HHI is between 1,500 and 2,500 points to be moderately concentrated, and considers markets in which the HHI is in excess of 2,500 points to be highly concentrated.

Based on figures in APRA’s Monthly Banking Statistics (March 2014), Australia’s banking sector has an HHI of 1640 looking at selected assets, and 1897 if you look at household lending in isolation. The banking sector is considered moderately concentrated according to this measure.

In fact the banking sector is materially more concentrated that it was prior to the GFC. It’s an open question why the government extended a guarantee to the big banks during the crisis, but not the mortgage securitisation market. It certainly thinned out the herd [3].

Apart from housing, as a young family groceries are our largest expense. And it is here that the lack of competition really bites.

Grocery market share graph

Proportion of all grocery dollars spent at each supermarket

The grocery market is dominated by Coles and Woolworths with a combined market share of more than 72%. Aldi and IGA represent about 10% each [4].

The HHI score for this industry is a whopping 2905, clearly a highly concentrated sector.

By controlling the stores, distribution and shelf-space, Coles and Woolworths can exploit their market power to extract lower prices from producers. Simultaneously the lack of alternatives allows them to extract higher prices from consumers.

Anecdotally, the rise and rise of own-brand products at these stores displacing profitable product lines (e.g. Milk and Black Label fruit juices to name just two) is becoming more prevalent, and a glaring example of how they are using their market power to crowd out other product makers. As consumers we all pay for this with higher prices and less choice.

Free and open competitive markets are a key source of our modern prosperity. Firms continuously innovate to outdo each other in achieving more with less, for the benefit of us all. But in order for this market mechanism to function effectively, competition must be encouraged, not repressed. Of all the responsibilities of an effective government, surely this is one of the most important.

References

[1] http://goo.gl/F9AdL6

[2] http://www.justice.gov/atr/public/testimony/hhi.htm

[3] Canada’s lesson in mortgage competition – http://www.australianbankingfinance.com/banking/canada-s-lesson-in-mortgage-competition/

[4] http://roymorgan.com/findings/5427-market-share-narrows-between-coles-woolworths-while-aldi-makes-gains-201402120013