More competition is often proposed as a means of moderating monopolies and oligopolies. It may be better to reduce competition for the electricity industry meeting our climate change needs.
There is a well-developed economics theory of competition which explains how a market with a myriad of small firms works. It requires freedom (ease) of entrance and exit. There are benefits from such ‘pure competition’ (and also some turbulence).
The conditions for purely competitive markets rarely apply, but often the structure of a market is near enough (or near enough with tweaks – what is called ‘workable competition’). However, the theory hovers over our thinking about markets generally. Thus the policy response: ‘we just need more competition’ to fix a market dominated by a single or a few firms (monopolies and oligopolies). Another is: ‘we just need a market regulator’. We have had commissioners in some markets for a couple of decades and we are still not satisfied. Such policies may well have some benefits but the market still works poorly.
We are trapped into the thinking we were taught in Econ101 about pure competition. Sometimes we need to think more radically. Here I focus on the number of significant firms in the market. The trick about pure competition is that the individual firms do not have to think a lot about other individual firms; rather they focus on the market generally and their customers particularly.
As the number of market players reduces, businesses start looking at one another and responding according to how they think their competitors will behave. You might think that this will be beneficial to their customers, but what this sort of behaviour can lead to is that the incumbents connive to raise prices. No, not meeting in smoke-filled rooms, but by working out how their competitors behave the market can, in effect, behave almost monopolistically. There are number of experimental studies involving players separated in different rooms who nevertheless work out how to attain cooperative outcomes without direct communication.
I was once taught that where there were more than five significant firms in an industry that the gaming became too complicated and the industry began to behave like the competitive businesses that workable competition was based upon. However, the ‘five’ was a rule of thumb; in particular circumstances it might be six; it might be four.
As it happens, New Zealand is riddled with markets where there are only a few significant players: one (domestic) airline, one port per region, two supermarket chains, three petrol chains, four banks, four electricity gentailers (generator-retailers). There are, of course, smaller firms in each market but each is dominated by a handful of players.
We should not be surprised that there often few market players in small isolated New Zealand. So we need to break away from dependence on theories developed for much bigger markets. At the time when the privatisation of the state electricity system into a number of competing companies was talked about, I looked at the size of electricity companies in the US to get a sense of where economies of scale ran out (as you would expect in a properly competitive market). The typical size was about the same as the entire New Zealand generation market. The implication is that we were trading-off economies of scale for alleged benefits of competition, albeit in a market in which there were only four significant players. (There have been instances in which the gentailers have clearly been gaming one another at the expense of consumers.)
There is a recent report by the NZCTU which draws attention to the fact that from 2014 to 2021, the four big gentailers distributed $8.7b in dividends but earned only $5.4b in profits. Firms that do this usually go bankrupt, but not in this case. It is a bit complicated to explain but, briefly, a monopoly is able to borrow secured against its future profits and pay the borrowings as dividends. That is what the gentailers have been doing.
New Zealand’s electricity industry faces a major restructuring as we struggle with climate change. Evidently we are going to have to reduce or eliminate our use of coal, gas and oil. We need to integrate better non-corporate-provided renewables (such as solar panels on rooftops); because their output fluctuates with the weather, we need additional ‘battery’ storage capacity. The local aluminium smelter is on its last commercial legs, with the potential to release a large block of electricity production into the domestic grid. In a couple of decades we are going to have a radically different electricity system.
How are we going to get to it. I fear that our thinking is too incremental, focusing on short term changes to the existing system in the vague hope that they will culminate in the new very different system. I cannot see any path which will efficiently lead to it given the current ownership structure. A set of competing businesses in an industry which needs restructuring is clumsy.
Allow me to make a proposal which will horrify the ideologues, but aims to get some longer-term sustainable and efficient system under way. Perhaps we need to renationalise the electricity industry to enable us to get the structural changes we need. Yes, it will be expensive, but less so in the long run when we get it wrong.
Some will react that nationally owned industries failed in the past and we should not reverse privatisation. I am more pragmatic. Public ownership can make sense, especially when there is the need for major restructuring as occurred in Britain after the Second World War. When the industry settled down, privatisation made sense. (In the New Zealand context, the privatisations of the 2010s deepened our share market, and increased opportunities for local investment.) But equally pragmatically, it may be necessary to renationalise an industry when major restructuring is required.
The danger is that a government may do the renationalisation with the best of intentions to restructure but a subsequent one will interfere for political purposes. That is a risk we have to take; it will be better than the current buggering around.