We are pleased to publish the following article by Dr. Justin Robinson. His article provides an in-dept analysis about the vexing and topical issue of the high cost of living in Barbados. We encourage the BU family to give the Doctor a warm welcome. We hope that he and his colleagues at the University of the West Indies are driven to write many more articles which would help the public of Barbados to grapple with some of the many issues which confront us.
Dr. Justin Robinson, Head, Department of Management Studies, UWI, Cave Hill holds a B.Sc in Management Studies (First Class Honours) (UWI), an M.Sc. in Finance and Econometrics (Florida International University) and a Ph.D. (Manchester). Dr. Robinson’s research interest are corporate financial management, derivatives, investments, risk management and financial market efficiency. He has published on these subjects in a number of international journals.
The cost of living is on the rise in Barbados and consumers are no doubt feeling the effects on their purchasing power. In a Nation newspaper article February 27, 2007, Decoursey Eversley of the Fair Trading Commission reports that there had been a twenty five percent (25%) increase in food prices over the last three years. There have certainly been further price increases since then and it’s no surprise that consumers are crying out, and there is a mad rush for solutions. The increase in prices is heavily influenced by the rising cost of oil and a surge in the prices of key commodities such as corn. These factors are beyond the control of any government and are driven by a complex set of factors relating to the rapid economic growth of places such as China, Brazil and India, fueling increased demand for energy and commodities, the increased cost of extracting oil, and the side effects of the rise of bio-fuels as a source of alternative energy among others. These trends are likely to continue for the foreseeable future and in my view require significant adjustments in the way governments, businesses and consumers operate. We may all have to make adjustments to our lifestyles and pay greater attention to our carbon footprints.
The general trend at times like these is to look for quick fixes, such as the recent agreement between the merchants and the government, as well as opposition calls for price controls. However, in my view the current situation should act as a catalyst for change, and we should take the opportunity to address the historic anti-competitive practices that have been widely talked about and deal with the high costs of doing business in Barbados generally.
Firstly, I want to express my views on price controls. The government and major retailers have entered into an agreement to reduce mark-ups on selected items. If it looks like a duck, walks like a duck and quacks like a duck, it is probably a duck. This agreement looks like price controls on selected items to me. The text book economic analysis of price controls is well known and has been widely cited in public debate. Economic theory suggests that price controls are likely to result in shortages and alternative means of rationing scarce goods such as long lines and black markets.
Without getting too technical, the short term effects of price controls depend heavily on the elasticity of demand and supply. That is, how responsive is the quantity demanded and supplied to changes in price. Demand (supply) is seen as being relatively elastic if a small change in price leads to a relatively larger change in quantity demanded (supplied) and vice versa.
In cases where demand and supply are relatively inelastic (as it probably is for food items in the short-term) it may be quite tempting for a policy maker to go for price controls. Economic theory suggests that in the short-term, when demand and supply are inelastic, the effects of price controls are small. The inelastic demand suggests that consumers (voters) place a high value on the good (s) and with inelastic supply (goods have already been ordered and shipped to Barbados) it may take a while for shortages and other side effects to show up. In the short term any effects may likely be felt in the form of higher prices of unregulated goods and services, the quality of services offered as suppliers attempt to maintain their profit margins by cutting costs and so on. In the longer term (time for the next order of goods to be placed), however, supply (as well as demand) is relatively more elastic and the well documented effects of price controls are likely to kick in. In the longer term, shortages can become quite acute due to lower levels of investment in the price controlled areas. We certainly hope this current agreement is a short term policy!
However, I would add one caveat to the discussion on price controls to date. The text book discussion of price controls and their effects is largely based on an analysis of competitive markets. Where there is less competition and firms have power to affect prices, some of the traditional objections to price controls become less compelling. For economists who express concern about the loss of freedom resulting from price controls, a relevant question in this case is, “Whose freedom?”. The loss of freedom caused by price controls is that of firms who have been exploiting the consumers of their products. The reduced profit margins from the price controls are simply a way of redressing the excess profits previously earned by dominant firms. Economic theory in fact suggests that faced with firms enjoying market power a policy maker can constrain price without creating a shortage by setting a price ceiling where the marginal cost curve cuts the demand curve.
Regulators and policy makers seldom have good information on demand curves, cost curves and elasticities of demand and supply and can very easily get their policies wrong. To the best of my knowledge, there is very little hard data on these variables in Barbados and policy makers are likely shooting in the dark. It seems to me that if the lack of competition in the distributive sector makes a case for price controls, given the uncertainty surrounding the impact of price controls, one is likely to do less harm by adopting policies geared towards increasing the level of competition in the market
When we travel to the United States and the United Kingdom we are often taken with the range of choice consumers have and the levels of competition. I would like to suggest that this level of competition and consumer choice is not purely a matter of large market size and a higher level of economic development. Competition in those markets is ever so slightly encouraged by the regulatory stance taken in terms of competition policy. Competition revolves heavily around seeking to minimize the level of market concentration and hence market power enjoyed by firms, as well as seeking to monitor and deter anti-competitive practices. Anti-competitive practices include, exclusive dealing arrangements, predatory pricing (dumping), limiting access to essential facilities (interconnection in the cellular market), tying arrangements (if you want the tomatoes you have to buy the eddoes and yams as well) among others.
Regulators typically make a distinction between “Rule of Reason Offences” and “Per Se Offences”. In the case of “Rule of Reason Offences”, one must demonstrate that an offence has been committed, that harm has been done and that a better solution is available. The approval of mergers and acquisitions are a typical example of this. In the case of “Per Se Offences” one only has to show that the offence has been committed. Agreements to fix prices, divide markets between sellers, and to restrict or pool output are common examples of per se offences. I will now cite a few examples of competition policy.
The courts in the United States have typically taken a hard line against collusion between firms. The precedent setting case, (United States v. Trenton Potteries Co. et al) involved 23 manufacturers of bathroom fixtures who had conspired to fix prices. Through their trade association, the manufacturers published standardized price lists, met to consider prices, and pressured one another to sell only at list prices. When the association was brought to trial, it claimed that the agreement did not harm the public. The trial record supported this position, indicating that fixtures were often sold below the list price. However, the Supreme Court rejected the request for a rule of reason interpretation of price fixing. The justices argued that “the reasonable price fixed today may through economic and business changes become the unreasonable price of tomorrow. Agreements which create such potential power may well be held to be in themselves unreasonable or unlawful restraints without the necessity of minute inquiry whether a particular price is reasonable or unreasonable. Firms may be forced to abandon overt methods and settle for less easily detectable and less-efficient methods of collusion.”
In August 1989 a case was brought against some of the most prestigious private colleges in the United States. For the 1989-1990 academic year tuition, fees, and room and board were $19,310 at Yale while at Harvard they were $19,395. The totals at Dartmouth, Colombia, and the University of Pennsylvania were also within $100 of those at Harvard and Yale. A case was brought against the universities revolving around the accusation that an administrator at Harvard informed his counterpart at Yale that Harvard was contemplating raising tuition by 6% for the next year. Yale then used this information to set its own tuition rates and a number of other universities followed suit. In 1991, as part of a consent decree, the universities being investigated agreed to refrain from sharing tuition information. In a consent decree the defendants essentially say we did not do it but we won’t do it again. The government agrees not to prosecute and the deal cannot be used as evidence of guilt in other proceedings such as private antitrust suits.
In a more recent development, the Office of Fair Trading in the UK has just fined British Airways (BA) 269 million pounds for agreeing BA and Virgin Atlantic discussed the amount they would charge customers to cover the increases in the price of fuel. BA stands to lose millions more in the face of class action suits from affected passengers. I wonder if any travel agents, tour companies or individuals are going to be parties to any class action suits. There is also a role for private citizens and other organizations in bringing actions against anti-competitive behaviour as well. We must do our part.
These examples are meant to illustrate the critical importance of competition policy in countries that are not typically accused of being unfriendly to business. The high levels of competition and consumer choice we observe in these markets is not merely a function of market size and the invisible hand. Competition is given a nudge by the very visible hand of government. While the debate continues in the USA and the UK over the application of competition policy, many concur that the impact of competition policy has come not from the results of litigation, but from firms modifying their plans to avoid the costs and uncertainties of possible prosecution. This has served to moderate the levels of market concentration and anticompetitive behaviours and by extension increase competition and consumer choice.
What precisely is the nature of our regulatory stance in terms of competition policy in Barbados? There have been a number of allusions to high levels of market concentration and anti- competitive practices in Barbados, some coming from highly placed government officials. In a Nation newspaper article of 27 February 2007, referred to earlier, the FTC reports that there is “some level of monopolistic pricing and high levels of market concentration in the wholesale and distribution sector in Barbados.” In another Nation newspaper article of Thursday 29 March 2007 Minister of Commerce, Consumer Affairs and Business Development Senator Lynette Eastmond said the FTC would be looking into monopolies in certain brands and the “Miami connection.” She went on to say “We have to look at how prices reach the price they do reach by the time they land in Barbados.” Meanwhile, the Nation newspaper of 22 February 2007 quotes Senator Eastmond as referring to a “cartel” in the Banking industry in Barbados. A number of academic studies have confirmed the prevalence of interlocking directorates in Barbados. Interlocking directorates create much potential for collusive behaviour and are usually frowned upon by the authorities.
I would certainly like to see more definitive information from the FTC about levels of competition in various sectors of the Barbados economy as well as instances of anti-competitive behaviour. The debate should be based on hard data rather than speculation. The FTC is a relatively new body in Barbados and I certainly do not want to be overly critical. However, competition policy is a critical variable at this stage of our development and in my view our competition policy appears to have been rather tepid to date. Many have argued that in a small economy if firms are going to be large enough to reap economies of scale and compete with international giants we may have to accept relatively high levels of market concentration. If one accepts this position that relatively high levels of market concentration are inevitable in small economies, then there seems to be an even greater duty for the competition authority to aggressively police anti-competitive behaviour.
There are many initiatives that can be undertaken to address the level of prices in Barbados. We certainly need to address the cost of moving goods across our borders, the levels of taxes and other costs that affect doing business. However, in an environment where firms enjoy significant amounts of market power and anti-competitive behaviours are tolerated and go unpunished, why would one expect a fair share of these savings to be passed on to the consumer in the form of lower prices? In the absence of competition, the lion’s share of these savings can easily be added to the profit margins of suppliers. Maybe this is why the Minister of State in the Ministry of Finance did not expect prices to fall with the removal of the cess.
Price controls are at best a temporary solution to the high and rising cost of living in Barbados. Our best bet in terms of attaining sustainable reductions in the cost of living is to increase the level of competition in the market. Competition is a wonderful thing but it needs a helping hand from consumers and a strong competition authority.
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