Where oligopolies rule

Are New Zealand’s banks any different to Australia?, asks Peter Lyon.

A leaked email can resemble a smoking gun. BP's pricing manager Susanne Lucas suggested in a recent leaked email that the oil company's response to falling sales in Otaki would be to raise prices in the surrounding region.

Otaki's petrol prices are 20 cents higher than other local centres. This is causing BP's sales to fall in Otaki. Her belief was that other oil companies would soon follow suit and raise their prices. This is a startling revelation that strikes at the heart of our accepted economic belief system.

According to basic economic theory, falling demand for a company's product should eventually necessitate a price cut. So what's going on here?

What is going on is very much in keeping with economic theory about a certain type of market structure which is unfortunately prevalent in New Zealand. This market type is called an oligopoly. It is characterised by a few sellers with a high degree of market power in determining the prices they charge.

Another crucial feature of this type of market is that the few firms in the market pay close attention to what other firms are charging. They much prefer higher prices to lower prices. The loser in such markets tends invariably to be the consumers.

Banks, telcos, electricity and petrol companies are some of the most obvious examples of this type of market structure in New Zealand.

The economic theory behind oligopolies is often associated with Joan Robinson, a brilliant Cambridge economist who published a book on imperfect competition in the 1930s. The theory emphasises that the few firms in such a market keep a very close eye on each other's prices.

They prefer to avoid price wars. In most countries it is illegal for them to openly agree on a price. So they tend to find other more subtle ways of determining a price that favours them over their customers and keeps their executives out of jail.

Although in New Zealand, unlike the United States, we seldom jail crooked executives unless they rob their own firm. One way oligopolies determine a price is for a dominant firm to set a price and others to follow.

Ms Lucas' email is eerily reminiscent of such an approach. Since 2008 profit margins in our fuel sector have soared from near the bottom of the OECD to near the top. In the past nine years they have operated in a very benign environment of non-activist government.

Meanwhile, the Financial Markets Authority has sent a stern letter to the banks demanding that they are open and honest about any bad behaviour towards their Kiwi customers. They need to come clean if they have been naughty like their Australian parents and counterparts. Yeah, right! This is in response to the Royal Commission in Australia that is uncovering all sorts of dodgy unethical behaviour by the Australian banks towards their Australian customers.

NZ Bankers' Association CEO Karen Scott-Howman has emphasised that the NZ banking environment is very different from Australia. According to Ms Scott, the NZ financial services sector is ''well managed, well regulated and has a high level of consumer trust and confidence.''

Apparently the banking industry is very different here. She didn't actually go into detail about how or why the banks are different here from their Australian parents. There does appear to be tighter controls on financial advisers since the GFC. But it is difficult to feel totally reassured.

Meanwhile, the BNZ , which is owned by the National Australian bank, has stated it will be ruthlessly vigilant in ensuring it maintains customer trust in New Zealand.

It also announced an 18% increase in net profit for the six months to March due to higher lending margins.

New Zealand lending margins are generally higher than in Australia. New Zealand is a very profitable country for its Australian bankers. It is still difficult to feel totally reassured.

In New Zealand, it is the function of the Commerce Commission to ensure our markets are competitive and consumers are not being ripped off by firms operating in oligopoly markets or monopolies. Real competition should ensure that consumers are not ripped off by paying higher prices or more fees or receiving substandard service.

Unfortunately the role of government bodies such as the Commerce Commission is often derided by those who have an unfettered faith in the efficiency of markets or who have a vested interest in maintaining a profitable status quo.

The Commerce Commission must play a crucial role in our economy. If it is underfunded or lacks the necessary armaments to ensure markets operate in the best interests of consumers, the end result is a huge transfer of wealth from ordinary folk to corporates often owned by overseas interests.

Unfortunately, corporate lawyers generally tend to trump government lawyers. The Commerce Commission must be well funded and carry a big effective stick.

Markets do function according to economic theory. Unfortunately this theory suggests certain markets, common in New Zealand, do not always operate in the best interests of society. Ms Lucas' email is confirmation of this.

-Peter Lyons teaches economics at Saint Peter's College in Epsom and has written several economics texts.

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