(Reprinted from HKCER Letters, Vol. 31, March 1995)

 

A Consumer's Report on an Immodest Proposal

Kelly Busche

 

The Hong Kong Consumer Council recently completed its Report on The Supermarket Industry in Hong Kong.1 The Council concludes the report with policy recommendations and proposed competition laws that are patterned after policies and laws in what the Council calls "advanced" countries. That should not necessarily give us confidence. Rather, "we [would be] well advised to keep our aspirations for competition law quite modest."2

The Consumer Council Report

The Report on The Supermarket Industry in Hong Kong states that it is designed to serve three objectives: "to examine the competitive environment of the supermarket industry, ... to evaluate the impact of the market structure on suppliers and consumers, ... [and] to make recommendations to promote fair competition and thereby enhance consumer interests." (p. 2)

The analysis is presented with a collection of data about prices and products available in what the Council calls the supermarket industry. Against these data, the report focuses on issues related to the concentration of the industry, including potential dangers to consumers, especially price collusion and such, that the concentration may entail.

The report concludes that the market is highly concentrated. Park'N Shop, Wellcome, China Resources Purchasing Company (CRC), and to a lesser extent, Kittie and Kettie Supermarkets (KK), have situated themselves in prime locations, and sometimes enjoy restricted access to housing estates. These factors, as well as scale and scope economies of at least the big firms, allow them to enforce "harsh" terms on suppliers. All told, the report concludes that although the Council has no evidence of any current practice of collusion or other behavior detrimental to consumers, the concentrated nature of the supermarket industry makes it ripe for such behavior, from which consumers should be protected.

The report ends with six recommendations which include, innocuously enough, encouragement of improved access for disabled persons and better customer service. Other recommendations go further. They include the introduction of "advanced country" legislation of the type associated with U.S. or British anti-trust or fair trade legislation, and monitoring and enforcement powers for the Council akin to those of the Hong Kong Securities and Futures Commission. Finally, there is a recommendation to produce a central planning body for the close control of supermarkets in outlying areas.

This Consumer's Report

The Council's declared objective is the enhancement of consumer interest, which it feels may be threatened by potential monopoly elements in Hong Kong supermarket operations. No one could find fault with such an objective, if only there were any evidence of a threat. The fact that there seems to be none raises questions about the recommended program and its objectives. First, it is not clear that the potential problems alluded to are actually serious. Second, it is even less clear that the proposed cure would be better than the supposed disease. And, even if control were at least initially valuable, could costly administrative agencies be dissolved when the monopoly threat dissolved, or would the administration grow even after the dragon had been slain, either by the new anti-monopoly apparatus, or by market forces independent of well-intentioned action?

The report begins by stating that Park'N Shop, Wellcome, and CRC have a "disturbingly" large share of supermarket sales, and this large share could be a sign that monopoly is present in the supermarket industry. An alternative explanation not considered in the report is that it could be a reflection of the cost structure and the arbitrary designation of "industry" which is used. A question not addressed in the report is, how important to consumers is the cost of any monopoly practices relative to the cost of controlling those practices?

How important is the concentration?

Monopolization of markets can be looked on with distaste, and concentration within markets may be associated with monopolization or cartelization. But it is not necessarily beneficial to restructure even a highly concentrated industry. There are at least two situations in which consumers would be worse off as a result of deconcentration.

If concentration really does involve rapacious monopolists, the alternative could be worse: several competing concerns who earn no monopoly profits but also have no access to economies of scale or scope which may have produced the concentration in the first place. Is the consumer better off? It will depend on the relative savings available from reducing the monopolist's profits on the one hand, and the higher costs for smaller suppliers on the other. And there has been no assessment made of the costs of implementing the deconcentration.

Concentrated industry does not necessarily mean monopolized industry. Even in cases where the former does imply the latter, the best thing for consumers may be to leave the situation as is, in view of high costs of enforcing successful deconcentration. There is a long history of anti-trust prosecutions which have been costly to consumers and would best have been ignored.3 In 1935, General Motors Corporation in the U.S. built its first new technology diesel-electric railroad locomotive. There were no patents involved and anyone could have started a competing company, although investment would have been expensive. A GM executive later would say that no one followed GM because they thought GM was crazy. By 1940, diesel-electric railroad locomotives were replacing steam engines. The differences in costs were so great that steam engines offered for free would be refused when the alternative was a GM locomotive at GM's (monopoly?) price. GM came to control 75 percent of the market and in the early 1960s, the U.S. Department of Justice brought criminal and civil suits, claiming illegal monopoly. The Department ended up dropping the suits, but taxpayers paid for its ill thought out actions, and GM had to pay unnecessary legal costs to protect itself.

Another famous anti-trust case was launched in the late 1960s against IBM, which at that time controlled virtually the entire computer market. By the time a decision was made, technology had left IBM as only one manufacturer in the mainframe, personal computer, operating systems and software markets. Competition and technology combined to make the anti-trust actions completely superfluous.

Concentration of Hong Kong supermarkets would be troublesome for consumers if there were collusion, either explicit or tacit, between supermarkets. The Consumer Council says it has found no evidence of collusion. The most important reason to be fairly confident that either there is no collusion or that collusion which might exist is not highly costly, is that Hong Kong has a policy of unobstructed imports of almost all items sold by supermarkets.4 To the extent that Park'N Shop or Wellcome were to try to maintain monopoly prices for their products, competition would yield profits for other suppliers who offered those goods. And cartels have a long history of breaking up because the members cheat on each other.5 The alternative would be a costly anti-trust approach, the benefits from which have increasingly been questioned, even by commentators normally considered friendly to the view that government produces good results.

Robert Reich, U.S. President Clinton's Secretary of Labor, argues that anti-trust has become an industry of its own which seeks more work to do in order to expand and be awarded with higher budgets from its funding agency, the government.6 Reich comments that the anti-trust bureaucracies have a "stubborn capacity for survival."7 John Kenneth Galbraith voices similar sentiments when he calls anti-trust a "charade ... [and] the last eruption of the exhausted mind."8 Lester Thurow sums up his view in the following statement: "Antitrust has been a failure. The costs it imposes far exceed any benefit it brings."9

Restricting concentration for its own sake is fraught with trouble. Concentration of an industry may reflect the fact that large firms are necessary to capture economies of scale or scope. If these economies result in a final product quality and price mix that pleases consumers, then consumers will benefit from and thus prefer large firms. If concentration is opposed or prevented, the effect will be to penalize those firms which have found economies which are practicable for large firms but not for small ones. Cost-saving innovations will not be pursued or developed so enthusiastically if anti-trust prosecution is possible or other restrictions on concentration exist. And even if an innovation is developed, the owner may be wary of gaining a large proportion of the market for fear of being penalized. A business owner can easily avoid capturing too large a market share by raising prices such that only a smaller proportion of the market will buy the product, but this does not necessarily benefit consumers.

Monitoring monopolies and restrictive trade practices

The Consumer Council report discusses various activities it calls restrictive trade practices. These include practices involving own-store labelling and loyalty contracts between supermarkets and suppliers. For example, one factory might produce identical dish soap with different labels for different supermarkets, and agree that it will not supply, say, Park'N Shop labelled soap to non-Park'N Shop stores. The following paragraph discusses why this may well benefit consumers. It is certainly not obvious how it would hurt them.

If Park'N Shop products were sold by other stores, such stores would not have the same incentives as Park'N Shop itself to protect the Park'N Shop name by monitoring the quality of Park'N Shop-labelled products. If a non-Park'N Shop store sold outdated or otherwise unacceptable labelled products, that would hurt Park'N Shop. It would hurt the non-Park'N Shop store which sold them less, if at all. Restrictive contracts which prevent just such a scenario from occurring may be the cheapest way to protect a supermarket's good name, which ultimately gets translated into higher-quality, lower -price combinations of goods for consumers.

The Consumer Council Report includes a recommendation that the government either set up a complaints mechanism for suppliers and consumers, or that the government empower the Council to examine complaints. In the latter case, the Council would have to have the presumably legal power to "take appropriate action...[and] have access to all relevant information and be given the authority to enforce compliance with its decision." (p.72) Beyond the administrative and legal costs associated with such an endeavor, restricting contractual arrangements between suppliers and retailers may well reduce their abilities to monitor quality or provide other services which consumers value.

Putting the Consumer Council in a monitoring and advertising role would probably be very useful. The Council, as it notes in the report, could usefully educate consumers about the difference between "best before" and "use by" designations, and the Council could monitor publicly displayed prices in the various supermarkets. Establishment of a board to control private business practices is unlikely to be of great benefit and may well have costly unintended results.

Planning standards and rights of operation

The Council, in one of its more intrusive recommendations, says: "The Government should devise a planning standard for supermarket establishments in remote areas....[and] the Government should require that the operation right of supermarkets be granted through open tender." (p.73) In addition to its concerns over supermarket concentration, the Consumer Council worries that if a housing development company is allowed to use its own supermarket in a low-population-density outlying area, there will be a risk of monopoly practices. And the Council is right. Unfortunately, the Council is unlikely to be right in thinking that enforcing open tenders for supermarkets will necessarily help consumers.

What does the Council have in mind when it speaks of open tenders for supermarkets in outlying areas? Does it foresee an auction for the rights to operate a supermarket in, say, a new residential development where there are now no other supermarkets? If so, how would supermarkets bid? If the bid were just on a dollar basis, the only change effected might be in who gets the monopoly profits, if there were any, and perhaps in the extra costs imposed by the bidding process itself. It is unclear that open tenders would reduce any damage to consumers. And if the bidding were done on say, potential guarantees of marginal cost pricing, how could that be implemented, and by whom could it be enforced?

To the extent that monopoly exists, as has already been asserted, it will probably arise as a result of a small market which will support only a limited number of efficient retailers. The results of enforced bidding could only be estimated with much more detailed information about the particular mechanism than is available in the Consumer Council report. Consider however, the following scenario. An open tender by bids of money is held to ensure that a developer will be unable to run a supermarket in his own housing estate. (Any bidding on marginal cost price guarantees or the like seems too difficult to consider.) Suppose a developer were originally to sell flats for $2 million and make the equivalent of $100,000 (present value) monopoly profits from a food store. Now suppose that it is possible to ensure that the designated operator of the supermarket could be monitored closely enough to guarantee marginal cost pricing in the supermarket. Any monopoly food store profits could just be capitalized into the price of the flat: Consumers would be indifferent between paying a slightly higher mortgage and a slightly lower food price, or vice versa. The developer could sell the flats for $2.1 million, which buyers would pay because of their access to lower food prices.

Arrangements between separate developers and supermarkets would add cost. To protect residences, the developer would surely look over the supermarket's shoulder to monitor fire prevention activities, for example. The two groups would have to negotiate over the problems arising because the owners of the supermarkets and buildings would have different incentives to provide parking, cleaning, and a myriad of other services. Enforcing open tenders or requiring more than one supermarket per however many people in order to provide competition may result in lower monopoly profits, but also in a combination of housing and supermarket services which would be more costly to consumers.

Incidental puzzles

In light of the general tenor of the Council's recommendations, parts of its report are puzzling. On the one hand, the Council objects to large firms dominating the market. On the other, it recognizes "the scale needed to pose an effective competitive threat to...Park'N Shop and Wellcome" (p.65); that "competition between supermarket chains is intense" (p. 26); and that "the market share of [Park'N Shop and Wellcome]...reflects the economies of scale enjoyed by the big two chains." (p.8) And, while apparently objecting to "harsh" terms imposed on suppliers, the Council acknowledges that the opposite side of the "harsh terms" coin is that large firms "have been able to obtain highly competitive and advantageous terms from suppliers." (p.14) Presumably, these "highly competitive and advantageous terms from suppliers" are part of what allows the big firms to draw large numbers of the consumer public. In another recommendation, the Council suggests setting up an avenue for complaints but at the same time acknowledges that where complaints have existed, "most were resolved satisfactorily..., [and] the big supermarket chains often promptly followed the Council's advice." (p.69) A conclusion that competition is in good shape and consumers are wellserved in Hong Kong supermarkets would seem as likely as any other, given the Council's comments.

Concluding Remarks

If wishes were horses, beggars would ride. In this case, the Consumer Council is wishing for an edifice which would produce the perfect competition found in first-year economics books, but with no consideration of cost. To establish a bureaucracy to get access to all relevant information and enforce compliance among supermarket operators is not free. Neither is it free to establish a planning commission that would determine the correct sizes and ownership of supermarkets in particular areas, even if correct determination were possible, which it may not be. Whatever it might cost to legislate the behavior of firms, the effects of specific contract terms between suppliers and supermarkets are not well enough understood to ensure that legal restrictions would be at all likely to produce useful results.

Under fairly general conditions, it is true that competitive markets may produce the most benefits for consumers. For that reason, the Council's objectives are unobjectionable. However, the Consumer Council provides no convincing evidence that there are important deviations from competition. And, even if the unspecified market imperfections do exist and are important, and the recommendations could be enacted to produce lower prices or other beneficial results, the stubborn capacity for survival of government agencies would mean that the cost of supporting these new or expanded agencies might continue long after they ceased to be beneficial.

The Assistant Attorney General of the United States (1981-83), in regards to anti-trust, has concluded that "arrangements [within and between firms] that achieve the integration of complements are wholly beyond our capacity to evaluate.... Given our present state of economic sophistication, we are well advised to keep our aspirations for competition law quite modest." 10 The Consumer Council is likely to be better off waiting until there is more agreement on the diagnosis of the disease before deciding on a cure. As young doctors are advised: First, do no harm.

NOTES

1. Hong Kong Consumer Council, November 1994. Page numbers without footnotes refer to the Council document.

2. W. F. Baxter, "Substitutes, Complements, and the Contours of the Firm," p.40, in Mathewson, Trebilcock, and Walker (eds), The Law and Economics of Competition Policy, (Vancouver: The Fraser Institute, 1990).

3. The example following is from p.51, John McGee, Industrial Organization, (Engelwood Cliffs: Prentice-Hall, 1988). He gives many similar examples.

4. Alcohol and tobacco products face tariffs.

5. A new study of international cartels lists those which operated before World War II. Thirty were terminated because of various forms of firm cheating and 14 were terminated by various forms of government involvement. See Valerie Suslow, "Cartel Contract Duration," Rand Journal of Economics, forthcoming, cited in Denis Carlton and Jeffrey Perloff, Modern Industrial Organization, (New York: Harper Collins, 1994).

6. Robert Reich, "The Antitrust Industry," Georgetown Law Journal 68 (1980).

7. Ibid, p.1070.

8. Quoted in Walter Block (ed), Reaction: The New Combines Investigation Act, (Vancouver: The Fraser Institute, [1986]: 199).

9. Lester Thurow, The Zero Sum Society, (New York: Basic Books, 1980). Emphasis added.

10. Ibid, note 2.

Dr. Kelly Busche is a lecturer in the School of Economics and Finance at The University of Hong Kong.

 

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