Quote of the Day: Challenging Monopolies

From excerpt from Forbes Magazine on how John Gokongwei owned Cebu Pacific [PSE: CEB] grabbed the airline industry tiara from Lucio Tan’s Philippine Airlines [PSE: PAL]. (emphasis mine)

It was Lance's father, legendary ragsto- riches entrepreneur John Gokongwei Jr., who had the idea to start Cebu Pacific. John, now 84, sits atop JG Summit Holdings, one of the Philippines' largest conglomerates, and a family fortune that FORBES ASIA pegged at $1.5 billion last year. His interest in aviation was piqued after reading about U.S. discounter Southwest Airlines at the same time the Philippine government decided to open up the airline industry. But Lance believes there was another layer to his father's interest: "About a year before we bid for PAL and lost. So when deregulation came up, well, my dad loves challenging monopolies."

Read more here

Monopolies, which signify as government privileges, operate on principles of anti-competition. This implies that monopolies are fundamentally inefficient, are driven by political goals and irresponsive to consumer demands which all add up to say that monopolies are slow to adapt to the changes in the marketplace.

And so when industries once dominated by monopolies are deregulated, this ‘chink in the armor’ becomes exposed. In a newly deregulated environment, entrepreneurs should pounce on the opportunities to challenge government monopolies as the Gokongwei’s did.

More Competition Via Deregulation For The US Electricity Industry?

The electricity market in the US appears to be opening up, that’s according to Energy biz editor Ken Silverstein, (bold emphasis added)

“While retail deregulation has fallen short of its promises, wholesale markets where industrials buy directly from generators are opening up. And the subsequent efficiencies are benefitting smaller consumers, who are also expected to see added improvements once their providers implement smart grid technologies that maximize efficiencies.”

And a genuine “deregulation” should translate to more competition. Adds Mr. Silverstein, (bold emphasis mine)

“Despite strong sentiments on both sides of the restructuring debate, it is too late to reverse directions in the wholesale market. That's because of the existing investments in unregulated generation and the sales efforts built to support that. The goal then is to create a fair market that enforces equal access to the grid and allows at least big buyers a choice in the matter. Any efficiency gains would then be passed down to smaller users.

“Deregulation has not been the panacea that supporters had hoped. But it is impractical to reverse course, particularly since customers are still switching.

“Under regulation, ratepayers may bear the risk of mistakes resulting from where and how investments are made. In competitive markets, however, the penalties for such mistakes fall on management and shareholders. Such accountability leads to better results, say proponents of deregulation, adding that the transition period from the traditional regulatory model to robust competitive markets takes time.”

Some comments:

The industry appears to be responding to the dictates of consumers more than the political supporters of a closed industry.

Perhaps this has been due to the ratchet effect or the “tendency of people to be influenced by the previous highest (or best) level of a factor (variable)” from the previous attempt to deregulate.

Next, this is exactly the difference between free markets and socialism: the profit and loss incentive versus collective risk taking.

Another, technology appears to be a critical factor in helping push consumers to demand for more competition.

Mr. Silverstein anew,

``The most significant catalyst for more efficient retail and wholesale energy markets will be less about new rules and regulations and more about technologies centered on the smart grid that can provide enhanced services and cleaner options. Utilities that incorporate those tools will, indeed, enjoy more competitive positions.”

If the trend towards more competition via deregulation is true, then this area should be a bright spot in an otherwise bleak- “socialization” of the US.

The Myths of Deregulation and Lack of Regulation As Causal Factors To The Financial Crisis

Professor Arnold Kling, former economist on the staff of the board of governors of the Federal Reserve System and also a former senior economist at Freddie Mac and presently a co-host of the popular EconoLog has an eloquent and impressive article refuting the popular myths peddled by liberal-progressives at the American.com, entitled Regulation and the Financial Crisis: Myths and Realities

His intro: (italics mine)

``The role of regulatory policy in the financial crisis is sometimes presented in simplistic and misleading ways. This essay will address the following myths and misconceptions

Myth 1: Banking regulators were in the dark as new financial instruments reshaped the financial industry.

Myth 2: Deregulation allowed the market to adopt risky practices, such as using agency ratings of mortgage securities.

Myth 3: Policy makers relied too much on market discipline to regulate financial risk taking

Myth 4: The financial crisis was primarily a short-term panic.

Myth 5: The only way to prevent this crisis would have been to have more vigorous regulation.

``The rest of this essay spells out these misconceptions. In each case, there is a contrast between the myth and reality."

In short, such misplaced arguments attempt to deflect on the culpability of the role of policymakers and their interventionists policies in shaping the financial crisis and instead pin the blame on "market failure" as justification for more government intervention.

Read the rest here

Professor Kling's conclusion:

``The biggest myth is that regulation is a one-dimensional problem, in which the choice is either “more” or “less.” From this myth, the only reasonable inference following the financial crisis is that we need to move the dial from “less” to “more.”

``The reality is that financial regulation is a complex problem. Indeed, many regulatory policies were major contributors to the crisis. To proceed ahead without examining or questioning past policies, particularly in the areas of housing and bank capital regulation, would preclude learning the lessons of history."

Yes, oversimplification of highly complex problems can lead to more prospective troubles than function as preventive or cure to the disease, especially when myopic prescriptions ignore the human behavior dynamics in the face of regulatory circumstances.

As David Altig, senior vice president and research director at the Atlanta Fed wrote in Markets work, even when they don’t, ``Markets are, everywhere and always, one step (or more) ahead of regulators"

Diesel Roll Back For PGMA’s Sona, MV Princess of the Stars Tragedy, Economic Realities of Cagayan’s Used Car Trade

``Beliefs have a social as well as an inferential function: they reflect commitments of loyalty and solidarity to ones coalition. People are embraced or condemned according to their beliefs, so one function of the mind may be to hold beliefs that bring the belief-holder the greatest number of allies, protectors, or disciples, rather than beliefs that are most likely to be true. Ideological beliefs are obvious examples.”- Steven Pinker, Department of Psychology of Harvard University

Some political economy notes and observations.

1. Diesel Roll Back For PGMA’s Sona.

Political accommodation feeds on the dangerous impression that oil companies have been “obscenely” profiting at the expense of the people.

Since almost all of the oil requirements of the Philippines are imported, this means that domestic oil companies essentially import all crude oil for domestic refining taking with it the risk of inventory storage, currency, political pricing aside from other risks relevant to the industry. Thus, profits are realized because of successful risk taking endeavors and not from price gouging as peddled by some politicians.

Refining companies earn from crack spreads (wikipedia.org)-“differential between the price of crude oil and petroleum products extracted from it - that is, the profit margin that an oil refinery can expect to make by "cracking" crude oil (breaking its long-chain hydrocarbons into useful shorter-chain petroleum products)”, which means profit can only materialize if they are able to passthrough their products to the consumers tacked with some margins. If oil companies are not able to do so they will incur losses. Vested interests see only the profits (survivorship bias) and not the risks or the potential losses.

The basic reason why oil companies can afford to roll back prices is mainly due to the significant fall in world crude oil prices. This essentially allows oil companies larger margins if sales are to be maintained based on present retail prices. Present retail prices covers inventory accumulated from recent crude purchases. However, a sustained decline in world oil prices should also translate to more rollbacks in the future.

Those arguing that the country’s oil deregulation as the main culprit to high oil prices should look at the Vietnam and China experience.

Both countries whose oil companies are state owned increased prices significantly (Vietnam 30% and China 18%) primarily not because of fiscal problems (although it has an influence) but mainly because losses in state owned firms have reduced or lessened supply output which has led to rampant smuggling, vast shortages and rationing.

Given the precarious state of the Philippine fiscal position, the idea of nationalized oil companies will only placate near term desires but at the expense of greatly higher prices in the future. The fundamental problem of oil prices comes from sustained government intervention around the world.

Oil companies ought to be more transparent with the public by communicating on the risk-reward aspects than simply accommodating politicians.

2. The MV Princess of the Stars Tragedy

It is a peculiar development why despite the repeated accidents by the same shipping company, consumers continue to patronize such private entity. The answer is the lack of choice.

None in the media has brought out the fact that the domestic shipping industry is a very tightly regulated industry.

Imagine, aside from 5 agencies that directly supervise the industry; namely, Maritime Industry Authority, Philippine Ports Authority, Bureau of Customs Bangko Sentral ng Pilipinas and the Philippine Shippers Bureau, there are another twenty six (26) other agencies directly or indirectly regulate the inter-island freight shipping industry (NEDA’s Philippine Institute for Development Studies). Incredible red tape!

With all these bureaucracy given the prevailing idea that government knows best, it is an oddity why the seemingly regular recurrence of the undeserving life losing tragedy.

Yet, media and the political circus continue to feed on the masses for more government intervention. Are 31 agencies not enough? Maybe Pagcor should be included as a regulating agency to allow bets on the next mishap? Why not nationalize? Hahaha.

It is quite evident that such choking bureaucratic entanglements represents by itself a significant barrier to entry which would naturally discourage potential rivals and limits challengers to the stalwarts, thus, the oligopoly or economic rents concentrated to a few inefficient sellers or providers.

Myrna S. Austria’s observation in her paper “Liberalization and Deregulation in the Domestic Shipping Industry: Effects on Competition and Market Structure captures the essence of the inefficiencies in the sector, ``Nonetheless, substantial competition exists in only a small percentage of the routes. A greater majority of the routes are still effectively monopolized, or experienced only mild competition. The top three or five companies in the industry effectively dominate the different routes. What is more striking is the large increase in cargo and passenger rates after the implementation of the reforms. The cartel-like arrangement that is observed to exist in the industry may have contributed to this.”

As we discussed in It’s Less About Oligarchy and More About Bureaucratic Crony Capitalism or in Philippine Politics: Systemic Defects of the Pork Barrel Political Economy, the major defects of the present economic system lies in the web of laws that shields competition on the turfs of the oligarchs. These oligarchic structure breeds inefficiency and continues to add up statistical fatalities in the domestic shipping industry, yet we never seem to learn.

3. Economic Realities over the Controversial Cagayan’s Used Car Trade

The recent ruckus over the used car imports gives some important economic realities.

One, imported used car has a thriving market, probably due to lower costs (reduced taxes due to export zone privilege?).

Two, laws meant to protect certain industries or interests have unduly created market inefficiencies resulting to higher domestic car prices. Thus, the price gap between the foreign owned local manufacturers and the imported used cars in the Cagayan Export zone has resulted to the underlying demand for the imported used car market.

Three, legal loopholes creates economic opportunities especially for those in power. The Cagayan Export Zone has used its privilege to go around the Executive Order (156) banning the importation of used car vehicles for resale in the country.

Fourth, politicians advance and protect their self interests and or vested interest groups other than those of the public.

In this case, it isn’t hard to qualify.

One, trade restrictions benefits car manufacturers at the expense of consumers, through higher prices caused by high taxes (seems like a modus operandi- taxes in exchange for protection from competition). Thus, the national government’s Executive Order is meant to “protect” the narrow interest groups allegedly for the benefit of the economy.

Some would probably argue that taxes serve the interest of the people. No, taxes pay for politician’s boondoggles and some of the people and NOT for the majority of the people (think Pork Barrel). People pay for the politician’s boondoggles directly through higher taxes and indirectly through higher cost of living, lower capital investments and unemployment.

Two, the key proponent of the Cagayan Export Zone (CEZ) has been an important ally of PGMA in the Senate hence the moxie to defy the law; another case of patronage politics.

Besides, here it is evident that politicians make their hometowns as “turfs” or “little kingdoms/dynasties” which make use of laws for the perpetuation of their political and economic regimes…hence more signs of oligarchy.

Another, the recent pieces of the political puzzles are falling into place…the motives behind the excoriation of the foreign chamber of commerce in early June has apparently been made evident. Aside, we now sympathize with our Supreme Chief Justice’s remonstration of "economic colonizers".

The Philippines needs to understand the functional benefits of well developed markets than relying on politicians for advancement. We need more economic freedom and less government intervention.