REFORM

COMMENTARY

30 December 2009

2010: the year of competition

Nick Bosanquet, Consultant Director, Reform and Professor of Health Policy,

Imperial College London

Thomas Cawston, Researcher, Reform

Health Policy, Imperial College London

Andrew Haldenby, Director, Reform

Key points

  • 2009 was a bad year for competition in the UK economy. The short term effects of the recession are inevitably anti-competitive: fewer firms in markets and fewer resources for firms to spend on new business ventures. But policy decisions have worsened the situation. EU state aid rules have been weakened. The UK Government’s industrial strategy is already diverting firms away from core activity and towards attracting government interest and support. In the UK public sector, Government made the public sector the “preferred provider” of NHS care.
  • Competition is in the public interest and stimulates wealth creation, innovation and diversity. Monopoly has the opposite effects. Academic research indicates that anti-competitive legislation lengthened the Great Depression (by seven years) and the Japanese recession of the 1990s.
  • 2010 needs a new approach. The goal of competitive markets hasn’t changed but its urgency has increased. The political focus on deregulation is importantbut will not deliver competitive gains in and of itself–competition needs active support to deliver its full benefits. Market failure must be challenged and actively addressed. That will mean a new business strategy focused on improvement of the general business environment rather than support for industries in difficulty; the renewal of competition in the banking sector; the reversal of EU state aid changes and the introduction of competition in the big UK public services of health and school education.

1. Time to compete

Competitive marketsdrive new products, new technologies, new business models, new efficiencies and above all, higher productivity and growth. Schumpeter called competition “a perennial gale of creative destruction”; Hayek described competition as a discovery process.[i] Countries with effective competition policies grow faster than those without.[ii] Up to 40 per cent of productivity differences between OECD nations can be accounted for by the level of firm entry and exit.[iii]

The role of new entrants is particularly important in changing business models and allowing greater access to products at lower cost. In the case of the airways, deregulation in the 1980s and 1990s broke the monopolies of the incumbent national carriers.[iv] New technologies and restructuring in the energy and telecoms markets broke the vertical monopolies of BT and British Gas.[v] The tremendous (if immature) innovation in the technology sector, from Google to Facebook to Myspace to Twitter, demonstrates the power of market entry. Each of these examples also shows that competition has a social benefit – through extending access to services throughout society – as well as an economic one.[vi]

Competition is just as beneficial in the public sector.[vii] Professor Julian le Grand has described the “other invisible hand” in public sector, with competition and choice in schools and health services being the best means to encourage quality services.[viii]The UK public sector is still based largely on monopoly but competition has improved services where it has been introduced, from tendering in general to welfare services to prisons.[ix]

Equally monopolies and dominant providers exercise market power, bringing inefficiency, higher costs and fewer innovations.[x] Research has shown that the decision to permit firms to collude to fix prices and supply lengthened the 1930s Depression in the US by seven years.[xi] Cartelised firms had less incentive to innovate and monopolies less interest in achieving greater efficiency. The basic absence of competition in the UK public sector is the key reason why public sector productivity has fallen in the last decade while average private sector productivity increased by 23 per cent.[xii]

2. 2009: competition in retreat

2009 has seen the balance of policy shift against competition. Key factors have included:

  • Public sector growth. The growth in the public sector, from 36.3 per cent of GDP in 1999-00 to 48.9 per cent in 2010-11, is drawing more resources into the less competitive part of the economy.[xiii]
  • Anti-competitive policy in the public sector. Most importantly, Andy Burnham, the Secretary of State for Health, shifted policy with the result that NHS providers should be the “preferred provider” for the delivery of NHS services. Previously, NHS commissioners had to be neutral in their choice of public, private or third sector provider. The policy is being challenged by the NHS Partners Network and ACEVO.[xiv] Other opponents of competition within the NHS include the British Medical Association. The BMA’s 2009 Christmas Card wishes a “Happy Christmas and a market-free new year”, despite the fact that principal GPs and partners in GP surgeries are self-employed individuals contracted to the NHS.
  • Easier provision of state aid in the European Union.[xv] The EU relaxed its prohibitions of state aid in December 2008 and has weakened the rules further in 2009.[xvi] The new rules will last until the end of 2010 and could be extended if Member States agree.
  • Merger in the banking sector. Competition rules were waived to allow the Lloyds / HBOS merger, initiated in 2008 and completed in 2009.[xvii]
  • Industrial strategy. 2009 saw the launch of an active industrial strategy, designed to provide government support for particular industries in danger. Ministers’ argument that the strategy is consistent with competition policy is undermined by their insistence that any government support will be limited and temporary.[xviii] The further danger is that businesses divert resources away from core activity and towards attracting government interest and support. This is already happening in the UK where other sectors are seeking the same degree of government involvement that the biotech sector is receiving via the Office of Life Sciences.[xix]
  • General recessionary effect. In the long term, recessions will be beneficial to competition. The difficult process of economic adjustment, with firms leaving and entering the market, will shift activity from low productivity to high productivity areas.[xx] But in the short term, recession will damage competition. Firms have less to spend on new business ventures. Some firms are leaving markets and others taking out capacity. Firms will develop defensive strategies aiming to raise prices on stable sales volumes. There will be a further reduction in competition from international trade.
  • Devaluation. The fall in the value of sterling will reduce the competitive constraint on industries that rely on imports.[xxi]

3. 2010: the year of competition

As the UK approaches 2010, its main political parties are united in the desire to increase economic growth. Better policy on competition will be one of the most important means to achieve this.

The private sectorneeds a clearer awareness of the importance of competition and of competition authorities. The size of the public deficit is rightly driving a debate across the public spectrum about a reduction in public spending, regulation and the scope of government. But a smaller government should not mean weaker competition authorities less able to intervene. Given the push against competition in 2009, competition authorities will need greater resources and greater confidence in 2010.[xxii] Professor Stephen Littlechild has made useful recommendations to improve the regulatory framework, for example by giving all regulators the duty to advance competition.[xxiii]

The banking sector has seen the greatest pressure for increased regulation. But that regulation can and should aim to deliver be greater competition, not less.[xxiv]

Politicians will need to give much stronger leadership in support of competition, consistent with independent competition regulation. They need to be prepared to stand up to vested interests even if this may cost short term political capital. In Europe, that means returning to strict policies on state aid before the end of 2010 if possible. In the UK, it will mean a new business policy focused on improvement of the general business environment rather than support for industries in difficulty.

The same arguments apply for the public sector. Competition and choice are the most important means to deliver both improved public services and a lower public spending level. Again, political leadership is vital as the public sector undergoes its own transition towards higher productivity, better management and close attention on the consumer.

Looking beyond 2010, greater competition needs to be go together with a shift in risk from government to society. In 2005 Tony Blair called for a public debate on risk, arguing there was danger “of having a wholly disproportionate attitude to risks we should expect to run as a normal part of life”. He recognised that “a risk-adverse business culture is no business culture at all.”[xxv] In the last year the insurance industry has called for a transfer of risk in areas such as health and pensions to the private sector, and the CII have discussed the benefits for risk in general. A more competitive economy and a less risk-averse society will do much to raise economic growth and reduce the scope of government, which are the defining domestic challenges for the next Parliament.

This Reform commentary draws on a policy seminar on competition policy held at Reform earlier in 2009, kindly sponsored by Virgin Media.

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[i] Quoted in Littlechild, S. (2009), Regulation, over-regulation and deregulation. Occasional Lecture 22, Centre for the Study of Regulated Industries.

[ii] Porter, M. (1998), On competition.

[iii] Nickell, S. (1996), “Competition and Corporate Performance”, Journal of Political Economy, Vol. 104.

[iv] Department of Trade and Industry (2004) “Economics paper no. 9 – The Benefits from competition: some illustrative UK cases”.

[v] Pollitt, M. (2009), “Does electricity (and heat) Network Regulation have anything to learn from Fixed Line Telecoms Regulation?”, JudgeBusinessSchool, University of Cambridge.

[vi] Bosanquet, N. (2006), “Healthcare to 2010 – making reform work”, in Haldenby, A. ed. (2006), Public service reform 2006-2010, Smith Institute. “The development of pluralism in the health service, in both provision and funding, is something that has traditionally been viewed negatively in terms of equity. This view has been greatly mistaken. Looking to the private sector as a whole, and in particular new industries, privately funded markets have been exceptionally successful in delivering equality of service. Even those on low incomes are able to afford the luxury of new services and goods such as modern communications and information technology, electronic equipment and international air travel. Given this evidence, we can be confident than the greater development of markets in healthcare will also achieve the improvements in equity for which Ministers have rightly called.”

[vii]For those public services where choice can be exercised, such as health and education. Services such as policing need a different form of accountability.

[viii] le Grand, J. (2007), The other invincible hand: delivering public services through competition and choice.

[ix] Department of Business, Enterprise and Regulatory Review (2008), Public Service Industry Review.

[x] Fingleton, J. (2009), Competition policy in troubled times, Office of Fair Trading. “Subsidies are rarely ideal: they are costly for the taxpayer, can prop-up less efficient firms, create dependency, and ultimately damage competitive incentives. Restrictions on competition are worse. In addition to higher consumer prices and the inefficiency, they are less transparent and can result in permanent changes to market structure. Ad hoc changes to the competition rules can also remove consistency and predictability for business, with additional harm to efficiency. Naturally, incumbent business will rarely object to subsidies or restrictions on competition.”

[xi] Lyons, B. (2009), “Competition Policy, Bailouts and the Economic Crisis”, Centre for Competition Policy. The National Recovery Act (1993) restricted competition. The Robinson-Patman Act, 1936, strengthened prohibitions of price discrimination. The Resale Price Maintenance Act also tightened policy on prices. The author added: “There is also evidence that lack of competition unnecessarily prolonged the 1990s Japanese recession. See Michael E. Porter and Mariko Sakakibara (2004), ‘Competition in Japan’, Journal of Economic Perspectives, 18.1, pp.27-50.”

[xii] Haldenby, A. et al (2009), The front line, Reform.

[xiii] HM Treasury (2009), Securing the recovery: growth and opportunity. Pre-Budget ReportDecember 2009. Cm 7747. London: TSO.

[xiv]Timmins, N. (2009), “Challenge to NHS rules on competition”, Financial Times, 19 December.

[xv] Brennan, K. (2009), Competition policy after the credit crunch. Speech at Chatham House, 26 June. “The ongoing programme of state aid reform led by the Commission has enabled Member States to deliver state aid interventions more effectively and quickly. When state aid is used well it is an effective tool with which to address market failures which hamper our economies and damage businesses, individuals and the environment. But used incorrectly it harms competition to the detriment of us all. All interventions must be closely scrutinised to ensure that they are limited in amount and duration to the minimum necessary. The Commission acted rapidly to create targeted flexibilities in state aid and competition rules to enable governments to take extraordinary action to fight off the crisis, especially the need to inject equity into banks. However, this new flexibility should be seen as a short term response to the turbulence in financial markets and its knock on effect on the real economy. It should be regarded as a temporary measure justified by prevailing economic conditions. We must be robust in the face of calls for long term weakening of the State Aid regime, especially for larger companies, and remain committed to withdraw the framework, as planned, after 2010.”

[xvi]In particular, Member States will be able to grant without notification of individual cases subsidised loans, loan guarantees at a reduced premium, risk capital for SMEs and direct aids of up to €500,000. All measures are limited until the end of 2010 and subject to conditions.

[xvii] Kay, J. (2009), “The new financial service leviathans: has competition been a casualty of the financial crisis”, Consumer Focus, 15 September.

[xviii] Brennan, K. (2009), Competition policy after the credit crunch. Speech at Chatham House, 26 June. In regard to emergency measures to provide loans to car companies: “I do not believe these actions compromise competition policy. They were taken to ensure that our businesses maintain essential investment and remain able to compete strongly in the global economy.”

[xix] Lyons, B. (2009), Competition policy, Bailouts and the Economic Crisis. CCP Policy Briefing. Centre for Competition Policy, University of East Anglia.

[xx] Stern, A. (2009), Implications for the wider economy. Competition Commission. “Recession can be healthy for competition. Why should there be three major US car companies if the public don’t want to buy the cars?”

[xxi] Waterson, M. (2009), Competition in recession: implications for competition in the wider economy – a few thoughts. Competition Commission. “Industries that rely on imports as the competitive constraint will be subject to significantly less competitive pressure so long as present conditions prevail.”

[xxii] Beardsley, S. and D. Farrell (2007), “Regulation that’s good for competition”, The McKinsey Quarterly.

[xxiii] Littlechild, S. (2009), Regulation, over-regulation and deregulation. Occasional Lecture 22, Centre for the Study of Regulated Industries. “"

[xxiv] Gregory, A. (2009), Competition in recession: what are the implications for competition in the financial sector? Competition Commission. “Economic efficiency needs a competitive banking industry lending at fair margins – particularly important for smaller firms without access to corporate bond market …. Can make a case for a banking industry of more smaller banks, banks separated by function, and organised markets for significant financial products. In general, implies more competition, not less – though arguably less competition in relaxing credit criteria.”

[xxv] Blair, T. (2005), Speech to the Institute of Public Policy Research, 26 May.