I should
probably preface this post with an apology for the awful title; Sorry. However one does not
often get to make cow jokes in the field of sociopolitical and economic
discourse, and woe betide he who passes up such an opportunity.
* * *
Free
market economics has been a powerful force in much of the western world for
some two hundred years or more. Under the auspices of Adam Smith's dead hand
successive governments have taken the theory that rational agents pursuing
their own utility maximisation is 'good' for society and tried to bend either
policy, or sometimes the world itself, to fit. This week gives us an excellent
example of failures in the assumptions of perfect competition undermining the
whole idea, and the chance for some prescriptive rather than purely descriptive
conclusions.
..
This is
actually the third attempt at this article. The first used the opening shots of
the current skirmish between dairy farmers and the supermarkets to segue into a
more theoretical discussion on "value". Ultimately this is a topic
that needs some more thought before being offered up for pseudo-public
consumption. Secondly it was going to be an explanation of why it was time for
some farmers to hang up their milk buckets and do something else (a point of
view that is, in part, discussed below). Finally on reflection it has become an
explanation of how our model of competition has failed, and what the farmers
should do to restore balance to the universe.
Perfect
competition is a nice idea, unfortunately the real world rarely obliges by
meeting any (let alone all!) of the assumptions required. In brief perfect
competition states that efficiency will be achieved in a market where;
- There are an arbitrarily large number of buyers and sellers.
- The products sold by each provider are interchangeable (or "homogeneous").
- There are no barriers to entry into the market.
- All consumers have perfect knowledge of the price at which each seller is selling at.
- Producers and Consumers are rational.
(Disclaimer:
There are a couple of other assumptions and some specific definitions of things
like profit, but the points above are good enough for this analysis).
From this
it should follow that the prevailing market price will become the cheapest
price at which any possible provider can sell and still remain in business. As
you knock out these assumptions you begin to get a higher market price, and by
extension less overall consumption (which is held to be a priorii worse than
more consumption - remember you live in a material world).
In perfect-competition world (PC World), the current issue is resolved
by some of the milk farmers ceasing to produce. Since they are unable to
produce at the prevailing market price they should cease to produce altogether
and get out of the way of the providers able to supply at the prevailing price.
This is the view being taken by many of the more pro-free market commentators
assessing the current situation. Originally this was also the view I was going
to take - attempting to defend a seller claiming the market price was too low
seemed to be skirting awfully close to the dreaded realms of the Planned
Economy - especially when there are other providers in the market still making
a tidy profit (Robert Wisemen - the suppliers of around 30% of Britain's fresh
milk posted a £34 million profit last year). After all, if you’re not going to
let the market decide who should decide the price of milk? A quango? The
government? The EU? 3D6x4?
The prosecution rests.
A change of perspective often helps in these matters. Let's start by
looking at which of those PC assumptions actually hold;
- An arbitrarily large number
of buyers or sellers. False
Although literally millions of people consume milk every day, farmers do not sell to the population. The main supermarkets are, for all intents and purposes, the only buyers. This means approximately 6-8 consumers. In May 2012 there were 10,724 dairy producers in the UK. This is close to an arbitrarily large number (with some caveats discussed below). - The products are
interchangeable True
Leaving aside the whole GM/Organic issue, milk is milk. - No barriers to
entry into the market False
There are significant costs associated with obtaining the land required to set up a new dairy farm and becoming certified by the Food Standards Agency. - Consumers have
perfect knowledge True
Slightly contentious, but I would argue the tiny number of consumers, coupled with the resources at the disposal of the supermarket buyers means that a supermarket is aware of the price available from all suppliers before committing to a purchase. - Rational
consumers and producers Debatable
To some extent this is a moot point. Its inclusion is to rule out fringe groups who don't make production decisions on price/profit factors. If you choose to supply based on whether there is an N in the name of the day no amount of economics is going to help you.
All in all - not great. Only 2 out of 5 can be said to
definitively be true, and, importantly, they are the two that benefit consumers
more than suppliers. An interchangeable product means that a supplier can't
leverage reputation or "unique selling points" to get a higher price.
Whatever you have - everyone else has as well. Perfect knowledge is obviously
an advantage by allowing a consumer to always pick the cheapest price.
The first point above will be addressed last since it is in effect the
solution. Moving on then to point 3; consumers indicate their preferences by
either buying (or not) at a prevailing price. If the price is too high
consumers don't consume and therefore either the price comes down or the
product ceases to exist. This seems intuitive because "no barriers to
entry" almost universally applies to consumption - and certainly applies
in the case of bottled milk. If you stop buying milk for a week there is
absolutely nothing to stop you buying it again in two weeks’ time when the
price changes. How do producers indicate their preferences? By producing (or
not) at a given price. Unfortunately now we hit the 'real world' problem. A
dairy farmer can't decide to not produce for three weeks because the price is
too low, and then start up again as if nothing happened. This means that the
producers don't have the same ability to influence the market as the consumers.
Or do they?
The first point about many buyers and sellers is the vanguard of a
fundamental underlying assumption - that no specific individual in the market
has more power than any other, and here we hit the nub of the problem. The
power all rests with the buyers. There are a small number of highly resourced
and knowledgeable buyers controlling virtually all the trades in the market.
They can chose to buy from any producer (because of interchangeable products),
they have knowledge of all the available prices, the producers don't have a
choice about who to sell to, and the producers can't decide to not produce
because of the barriers to re-entry when the price changes.
Addressing this imbalance is actually very simple - the producers become
unionised for the purposes of negotiating trade prices. If a small number of
buyers meet an equally small number of sellers balance is restored. No longer
can one side or the other use the threat of withdrawing from the market to
influence the price unduly in their favour. Although the barriers to re-entry
remain as a point against the producers I can't see a supermarket relishing the
prospect of losing the ability to sell milk (with 165 million cups of tea per
day being made in Britain milk is a great way of getting people into
shops).
Would we see a higher price for milk in the shops? Probably not - the
price between the supermarket and the public consumer is a different game
played by different rules. Would we see some milk farmers still going out of
business? Probably - ultimately farming has been decaying as a % of total
economic activity since the Stone Age, in fact it is one of the underlying indices
of civilisation. Would we get a get a price determined by a reasonably open
market where evenly empowered agents negotiate in their own best interests?
Yes.
Problem solved.
/Happy Trails
Z
No comments:
Post a Comment