27 Mar 2020
(By Peter Ormosi and Andreas Stephan) When the escalation in Covid-19 sparked panic buying and shortages of key products, UK supermarkets asked the government to consider , to allow them to co-ordinate supplies and reduce shortages. On 25 March 2020, the stating that,
Throughout the UK, business are… providing essential goods and services to consumers, to ensure key workers can carry out their important tasks and in getting the country through this crisis. The CMA understands that this may involve coordination between competing businesses. It wants to provide reassurance that, provided that any such coordination is undertaken solely to address concerns arising from the current crisis and does not go further or last longer than is necessary, the CMA will not take action against it. (paras 1.4 and 1.5)
This blog piece examines the consequences of providing this reassurance and asks whether it is a good idea.
What could coordination amount to?
It is fairly common in times of national and international crises for governments to deviate from the economic and commercial wisdom of ‘normal times’ and to turn to increased cooperation and concentration of economic interests. This has included wartime cartels and those permitted during the Great Depression of the 1930s. The academic studies into these periods in history are too numerous to list here, but it is far from clear that allowing coordination during times of crisis is a good idea.
Competition laws closely reflect what economic theory teaches us: in most cases it is competitive markets that can deliver the best outcome for society. For this reason, most forms of coordination between businesses is illegal in the UK. This includes coordination between supermarkets, even if it only relates to distribution and delivery lines. So why do supermarkets believe that a restriction of competition is needed to tackle the present crisis?
One argument is that coordination allows them to achieve a more reliable supply of food in the face of the current spikes in demand for key products. This means sharing stock data and coordinating supply networks, distribution depots, delivery vans, which stores should remain open and possibly also the exchange of staff. For example if one supermarket is well stocked with fresh vegetables and the other one with non-perishable goods, then it might make sense to coordinate the distribution of these products between them, so customers have access to these products in both supermarkets.
Another reason is the danger of higher prices resulting from bidding wars, sparked by the shortage of some items coming from suppliers. Coordinated purchasing from suppliers might be able to eliminate this and keep prices low. Finally, staffing could also be a problem, if some areas are affected by large numbers of ill or self-isolating staff, it could make sense to shut down some stores, to ensure others can remain open. But how well do these arguments stand up to more nuanced scrutiny?
Is the problem really about competition law?
We are yet to hear a detailed and convincing argument from supermarkets, to show it was unhindered competition that contributed to the recent difficulties in meeting demand. Arguably, the shortages in supermarkets have not come about because of any fundamental problems relating to supply, that coordination between competitors will address. Rather it has resulted from a failure by retailers and government to take decisive action to stop panic buying and stockpiling. This might have protected those hardest hit by the shortages: low income consumers, the vulnerable and essential workers who do not have time to visit multiple supermarkets to fulfil their basic shopping needs. Indeed, the need to visit more than one supermarket only contributes to the spread of Covid-19.
One driver of this high demand comes from those seeking to profit from the crisis by scooping up supplies of high-demand products like hand sanitiser, only to sell them on at an enormous mark-up. Ironically, it is old English common law offences of regrating and engrossing that would perhaps be better suited to dealing with such practices, as these practices are more reminiscent of the effects of plagues and bad harvests experienced in the Middle Ages. The CMA , using consumer and competition law powers, but ironically may have to ask the government for emergency legislation if problems cannot be addressed using existing laws.
It is in fact difficult to see how coordination will help ease any of the issues identified above. For example, balancing out stocks could as easily be achieved by supermarkets trading with each other. Such back-and-forth bargaining would be much more likely to keep prices down than allowing a concerted action and coordinated prices. It is also doubtful that coordination will help avoid unwanted bidding wars between supermarkets, which might naturally be constrained by competition on prices charged to consumers. Indeed, even if prices paid to suppliers did go up, it would only stimulate more production of those products, which is exactly what is needed. Coordination may simply result in more stable supply through higher prices and less being sold.
Even if these assertions turn out to be untrue, there are other reasons to be concerned about allowing coordination between competitors.
Public v private objectives of a retail cartel:
A key problem is that the private incentive to collude is not aligned with the public interest objective, of allowing coordination to help deal with the crisis. Private cartels are typically formed to increase prices either directly, or by limiting supply. It is of course legitimate for the government to decide that the need to ensure reliable supply, or stable employment and prices, is a legitimate policy objective that justifies a short-term reduction in competition. This was the case, for example, in the US under the New Deal, where cartels were allowed in order to prop up wages and employment. But in the current climate the arguments for a UK retail cartel (albeit a partial one) are dominated by the need to increase or stabilise supply, i.e. exactly the opposite of the incentives driving a private cartel.
Historically, there are many instances of crisis cartels encouraged or set up by governments. Yet, these were often met with the realisation that the incentives of private cartels and public interest goals they were supposed to serve, were misaligned. This in turn led to state action to transform these into public cartels. Something similar was documented by Newman (1948), who noted that privately formed cartels in Germany, which were condoned by the Nazi regime in the state’s interest, were gradually replaced by government-run cartels, once the government realised that,
“a captain of industry who determined the kind, quantity, and price of his products exclusively from the point of view of his own convenience and profit had to be converted into a servant who cooperated in accordance with the wishes of a public authority standing above the interests of the producers.” (Newman, 1948, p.577)
Many other wartime cartels, whose objective was to maximise supply, were government run, which was the reason there was little deviation from the government objective of allowing these cartels – i.e. the government could enforce the increase in supply.
For this reason, a lot hinges upon the ability to ensure that the cartel operates along the public interest lines, rather than following their own private incentives to limit supply, raise prices and share markets. It is notable that many cartels begin with legitimate exchanges of information between competitors, often encouraged by a government department or regulator, but these often go on to become harmful cartel arrangements.
How do we know they’ll stop?
The CMA guidance says businesses are not being given a “free pass” and that it will not tolerate “non-essential collusion”, such as going beyond what is necessary to meet the needs of the current crisis, excluding smaller rivals, abuse of dominance, or attempts to keep prices artificially high (para 2.4). The key question is how can we be sure the coordination does not go beyond what is necessary and that it will stop once the crisis is over?
Once retail collusion is allowed, it is very hard to monitor it, to ensure that it only happens to the extent that is necessary and in the public interest. By being allowed to fully share data on their stocks, businesses develop a level of familiarity with their competitors that did not exist before. This means that even after the relaxing of competition rules ceases, there will still be increased ability to continue colluding (but now tacitly). This sort of behaviour, coined residual collusion by Harrington (2004), is not unprecedented in the history of cartels. The government could still consider that a post-crisis higher price level is worth paying for more stable and increased supply during the crisis. However, that would assume that collusion increases supply – which is doubtful.
If output under competition was not sufficient, why would cartel output be any better?
The epidemic, and the subsequent government measures have created a sizable challenge to UK businesses. Supermarkets are no exception. They are facing an enormous hike in demand, there is an unprecedented increase in the need to deliver, both of which are creating shortages and sporadic supply, which is why they are asking to be allowed to co-ordinate to better meet this increased demand. As the price elasticity of consumer demand is swiftly eroding, supermarkets are seemingly pushed to compete on other dimensions (such as supply stability, or to preserve a ‘can-do’ reputation). Imagine that one supermarket cannot cope with the increased demand and folds. This is something that would have implications far beyond the crisis period.
There are two ways to avoid this. One is, by competing, i.e. trying to be better than their competitors. As students of competition policy, we believe this is the solution which provides the best outcome for society. But supermarkets can also start rent seeking, i. e. asking the government to exempt them from anti-cartel laws, and thereby they can agree that none of them will outperform the others. The relaxing of the present rules may even cause supermarkets to close some stores, so as to concentrate supply where it is needed most. Coordination will ensure those closures do not overlap with each other (thereby ensuring that at least one supplier remains in each geographic location). But ensuring that there is at least one supplier in any area does not equate to ensuring that there is sustained supply of food in these areas. On the contrary, economic theory would suggest that reduced competition is unlikely to lead to a sustained supply of food.
To conclude, the relaxing of competition law may be justifiable in the face of such an unprecedented crisis, but the wisdom of allowing coordination is far from clear and the CMA should work to ensure that any relaxation of competition laws has as few unwanted effects as possible. The effects on markets will also be closely scrutinised by academics, who will study both its effects during the crisis and what happens afterwards.
Although eonomists aren’t so worried about price gouging as long as supply is elastic enough, which would mean that higher prices would trigger more supply – exactly the outcome we want to see.