ROGER PARTRIDGE: Commission still confusing competition with counting

Imagine that a public health authority publishes a report on the nation’s diet. After 22 years of data and a 100-page methodology, it announces the four least nutritious food groups. They are: beverages, snacks, prepared meals and condiments.

The categories tell you nothing, because beverages include both water and vodka, and snacks include both carrot sticks and deep-fried Mars bars. The four least nutritious food groups are not food groups at all. They are categories with contents differing so much that any encompassing judgement about them is meaningless.

The Commerce Commission’s first State of Competition Report, released earlier this month, takes a hundred pages to make the same mistake. After 22 years of firm-level data, and a composite ranking exercise, it has identified the four least competitive divisions of the New Zealand economy. They are: electricity, gas, water and waste services; financial and insurance services; information media and telecommunications; and mining.

‘Financial and insurance services’ includes retail banks, wholesale banks, insurers, fund managers, KiwiSaver providers, finance companies and brokers. ‘Electricity, gas, water and waste services’ includes generation, transmission, distribution, retail electricity, gas pipelines, gas retail, water supply, wastewater and solid waste. These are grouped together for the national accounts, not for markets.

The report itself concedes the point. Its own methodology section warns that the industry classifications it uses differ from market definitions typically used in competition assessments. But the concession is in small print. The headline rankings are in the executive summary.

The report’s own structural data substantially undermines the headline narrative. The Commission’s two main concentration measures both moved in the opposite direction from its overall conclusion. The share of the largest five firms across the New Zealand economy has fallen steadily across the whole 22-year period. The Herfindahl-Hirschman Index, the standard measure of concentration, has done the same. If the test of competition is whether large firms are losing share to smaller rivals, then for two decades the New Zealand economy has been passing that test.

The report tries to rescue its headline by leaning on business dynamism and performance measures instead of concentration, and by noting that entry and exit rates have declined. But declining entry can equally reflect maturation, satiation, scale economies, or simply natural constraints on a small open economy. The report acknowledges these alternative explanations, then ranks anyway.

A deeper problem is that the report does not measure international trade, the single most important source of competitive discipline on a small economy. The Commission concedes that a measure for the level of import competition for each industry was not available, and uses imports used as inputs as a proxy for import dependence rather than import competition. But a New Zealand retailer competing with goods landed from China faces fierce competitive pressure, whereas a manufacturer using imported steel as a production input faces none. The proxy cannot distinguish between the two, and the rankings do not adjust for either.

In a small economy, competitive pressure often comes less from the number of incumbent firms than from how open the market is to new entry. Competition economists have understood for more than forty years that the number of firms in a market is a weaker signal of competitive intensity than the conditions of entry. A market with three firms and no barriers can be more competitive than a market with eight firms and high barriers. Incumbents discipline themselves against the threat of entry, not only against the firms already present. The report measures the firms. It does not measure the barriers.

The most binding barriers in the sectors the report has named as least competitive are regulatory, and beyond the Commission’s reach to remove – though within its market-study powers to examine and report on. The Reserve Bank’s bank capital settings raise the cost of entering retail banking. Resource Management Act planning delays raise the cost of entering supermarket retailing.

The report could have identified the regulatory barriers that bind in these sectors. Instead, it identified sectors and proposed the Commission’s own future work as the response.

The New Zealand Initiative’s 2018 report Who Guards the Guards? identified governance failures at the Commission. The 2025 Rebstock Review, which Parliament is currently acting on, addressed these failures. Among its recommendations was that the Commission publish an annual State of Competition Report and proactively engage with Government on its policy implications.

The Commission has an incentive to deem things uncompetitive. The more it does so, the more its powers expand. Each of its annual reports will therefore only add to the four sectors identified in its first. There will be no year in which the Commission concludes that competition is functioning adequately and that its work programme should shrink.

A competition regulator can do useful things. It can prosecute cartels, block anti-competitive mergers, and conduct market studies examining whether barriers to entry reduce competition. The State of Competition Report does none of these. Instead, it is a ranking exercise at a level of aggregation the report itself warns is unsuitable. Nonetheless, it asks readers to treat the ranking as a diagnosis.

A good diagnosis points to a treatment. The Commission has measured something other than the disease and prescribed more visits.

This column was first published in BusinessDesk on 22 May. It was sourced from Plain Thinking