Oligopoly

There has been a long gap since my last blog. I had a load of academic writing to complete which occupied my mind. That's done now, so here goes. Like most of us I was pretty horrified by the energy price increases, but even more alarmed by David Cameron's exhortation that more competition was the answer. I don't know whether he or George Osborne studied Economics at school or university (I think they both did)but they seem to have forgotten what they learned about oligopoly theory. Incidentally, Economics rightly gets a bad press for the unrealistic nature of many of its theories, but the oligopoly bit is intensely practical and substantially accurate in the real world. For those who don't know or remember, oligopoly means competition among the few. The energy generation and supply market is a classic oligopoly with its six dominant players. The theory says that oligopolies tend to behave in predictable common ways and have similar characteristics. Among these are : There are natural barriers to entry for new firms. This usually means that the required investment is so prohibitively high that smaller firms can't enter or complete. They do not enjoy the economies of scale of the existing players. Of course if such barriers are created by the existing players, they are artificial and invariably illegal. This would make the oligopoly in question a cartel. There is no suggestion the energy market is an illegal cartel. The main characteristic is called price 'stickiness' and a tendency for all the players to charge a similar price. There is a natural resistance to competing on price. This is for the following reason : If one firm drops its price below that of the others in an attempt to capture market share, it fears that all the others will follow suit so it will gain nothing. Furthermore, if such a price war occurs no one will gain (it becomes a zero-sum game) and everyone will lose profitability because prices end up lower. We consumers would love this to happen but it just doesn't. Think about it. Go to a number of electrical stores and compare the price of the same TV set or washing machine. They'll all be the same. By the way, a friend of mine, noticing this, used to go to such stores and ask each one to persuade him to buy a product from them rather than the shop over the road which was asking the same price. He often was offered a discount. Worth a try if you've got the bottle ! Don't try it with energy companies. Well, on second thoughts why not ? It often works with insurance companies. Normally firms engage in non-price competition. This means charging the same price but claiming their product is better quality, or their service is superior. Airlines typically do this. The problem with the energy market is that gas is gas and electricity is electricity no matter from whom we buy it. (note how petrol companies face a similar problem. They try to claim their petrol is better but we know its all the same). This means there is no competition at all, either on price, quality or service. What they have done is produce various different tariffs to give the appearance of competition. There has been one further problem with competition in the energy market. In competitive markets consumers are said to have 'perfect knowledge' of prices and products. They can also switch easily from one supplier to another. The supermarket market is like this. In the energy market consumers are confused by various price regimes and it is difficult to switch. Quite rightly the government forced the banks to make switching easy, but this has not happened in energy as yet. The energy market is not really a 'failed market' as many say it is. This is because oligopolies are expected to behave more or less like this. Oligopolies, in other words, are bound not to compete in the way other markets do. All this means that the idea that more competition is the answer will not wash. I'm afraid that even neo-liberals must accept that some state intervention is required.