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Eucken and the Threats of Monopoly
I am reading Walter Eucken's book on Principles of Economic Policy, which I last read as a student 20 years ago, and which was written almost 60 years ago. As far as I could find out, Eucken's work is not available in English which is really a pity, for two reasons. Firstly, it is a good book in its own right, explaining in clear terms how an economy works, and how politics influences the economy. Second, Eucken's thinking has shaped the economic order in Germany since the 1950s (notably via politicians such as Ludwig Erhard and Alfred Müller-Armack), and hence indirectly the economic order that shapes the EU. Understanding these roots is essential to understand today's institutions (formal and informal).
A difference to other introductions to economics is Eucken's strong focus on monopolies. This includes not only firms dominating a market (the mainstream definition of monopoly) but cartels and industry associations that jointly control a market or erect barriers to entry, and thus are able to restrict the volume sold in a market - and thus to raise prices. Eucken's views are informed by the periods of the 'laissez-faire' in early 1800s when removal of rules dating back to the middle ages stimulated unprecedented economic growth, but also by the late 1800s and early 1900s when dominant industrial firms, alone or acting together, attained to not only market power, but political power that they used to protect their economic interests to the detriment of ordinary workers.
Eucken starts from the observation that even at times of starvation, some companies have destroyed food stocks to maintain higher prices, certainly an extreme but true observation, for example in the recession of the 1930s. Restricting the amount of produce on the market enables monopolists to increase their profits, as every microeconomics textbook explains. Moreover, monopolists may overinvest in production facilities because that enables them to cement their market position, again causing inefficiencies from a macro economic perspective. Under these sorts of market structures, private property - the backbone of growth and welfare in a free market economy - may harm the welfare of society. Hence, an economic order needs to build a corrective, competition policy.
Monopoly includes single demand-side monopoly (also known as monopsony). For instance, if there is only a single employer in a region - Eucken uses Silesian textile mills as example - then this single employer can dictate wages and worl conditions and exploit workers. Karl Marx observed textile mills in the English midlands and concluded that private property of the means of production was to blame. Eucken disagrees with this analysis (p.47). Private property has these undesirable effects only because of monopsonistic labour markets. If workers have alternative places to work, or if they have a strong union creating a counter balance, then the impoverishing effects of industrialization would not occur. Eucken cites evidence of improved income of industrial workers since the late 1900s as evidence.
The concern about monopolies on either side of a market leads Eucken to assign competition policy a central role in an economic system. The competition office, independent like the Bundesbank, thus played an important role in the German economic order, which arguably was weakened when competition responsibilities moved to the EU in the 1990s.
Since Eucken's time, economists have taken more differentiated views of monopoly, considering in particular dynamic effects. The prospect of temporary monopoly is a key motivator for innovation, for example patent protection for pharmaceuticals, or big buck buy-outs by Microsoft for entrepreneurial start-ups. Moreover, many economists argue that monopoly power ought to be considered not by actual market shares because the threat of entry can force monopolists to behave 'as if' they were in a competitive market. That said, the threat of monopolists restricting production volumes or preventing entry (for example through regulation they influence) will always be a treat to a market economy, though the means they use change.
Obliquity in a Bath Bookshop: John Kay
Last week, a traditional bookshop in Bath had invited not a poet or novelist to read from a new book, but John Kay, a senior academic economist and FT columnist. A relaxed evening off work, turned out to be most thought stimulating - and in fact directly relevant to (the leadership aspects of) my own work.
John Kay's key argument is that great objectives are often not achieved directly, but in indirect - even serendipitious - ways. While drawing on examples from all walk of life, he mostly focused on companies. Why is it that companies that publicly subscribe to shareholder value, do poorly in terms of creating shareholder value in the long term, and often do not survive (at least according to his data)? He talked of examples like Boeing, Marks & Spencer and ICI that once were focused on developing the best aircraft, retail services and chemical components. Yet, at some stage in the 1990s they were taken over by a new CEO who promised to increase shareholder value, and failed.
Why is that? Kay offers a variety of partial answers, none of which fully explains the phenomenon. On issue is that emphasizing shareholder value fosters a culture of 'greed is good', and unsurprisingly employees adopt such attitudes towards their personal benefit as well, to the detriment of the company (most obvious examples are Enron and Goldman-Sachs). Another line of thought focuses on uncertainty and the inability of humans to fully comprehend their environment, and thus centralized planning 'by numbers' is likely to fail because it creates counterproductive incentives. Flexibility, real-politic and adaptation on the ground are needed that cannot be delivered by numbers-driven managers.
Kay has not been very sharp on managerial implications: Given that singular focus on shareholder value fails, what approach should managers pursue? It seems that companies focused on their values in a broader sense - less clearly defined - do better in the long term, as do companies driven by the ethos of a family firm or by the legacy of famous founder.
I challenged Kay to apply his reasoning to explain the decline of British manufacturing, mentioning Rolls Royce as one of the few success stories of recent years. Kay quickly notes the contradictory lessons ones might draw from the Rolls Royce example: In the 1970s, R&R went into liquidation because it focused too much on engineering excellence and paid too little attention to its bottom line. Today, it is this engineering excellence that is the core capability that enables the firm to create shareholder value. Business is, John Kay concluded, like steering a boat on the river: if you get to close to the left ban, you need to steer right; if you get to close to the right, you need to steer left. The real skill is to keep the boat in the middle of the river - a balancing skill.
On further reflection, a major issue seems to be the confusion between objectives and metrics. We use metrics, such as shareholder value, as indicators of success. Yet, our real objectives are much broader and often less well defined - such as a prosperous firm creating benefits for everyone associated with it. Metrics as performance indicators are important, but we shouldn't confuse them with objectives. I will need to keep thinking about this ... In the meantime, I recommend the book:
What IF? Alternative Preference Voting System
An alternative to the current first-past-the-post and proportional representation is an 'alternative preference system', as it is applied currently in Australia and for the election for the Mayor of London. The idea is similar to a run-off election as used in France, but rolled in with the original election. Hence, each voter has to rank the candidates, and the votes then are counted as if there are multiple run-off elections until one candidate gets more than 50% of the votes cast.
I tried to do a simulation for this one, but it is really a lot of work, and it requires a lot of assumptions. So, I assumed for example, 3/4 of Labour voters go LibDem in the run-off, 2/3 of LibDem voters vote Labour in the run-off, and so on. I choose the London region for this simulation because it has a wide variety of election results. Of 73 constituencies in London, in 32 the winning candidate had over 50% of the votes (14 Cons, 17 Labour, and 1 LibDem). Of the hypothetical run-off elections, 25 are between Cons and Labour, 5 between Cons and LibDem, and 11 between Labour and LibDem. Simulating the likely outcomes of these run-offs, I obtained only 4 differences to the actual results: 3 turned from Cons to Labour, while 1 went the opposite way. No changes affected the LibDems. I had expected more changes, but alas there were not.
The problem with this simulation, is that the actual votes may already reflect voters second preferences - so in practice we may see a wider spread of first preferences in the alternative preferences system. Another consequence is likely to be that even in 'safe' seats parties would be reluctant to put up a candidate holding polarizing views, because that would allow a centrist candidate from any of the other parties to make it in the run off, and win on second preferences. Thus, within the parties, more central candidates may gain influence vis-à-vis the 'hawks'. But more importantly, a candidate with over 50% of votes could claim greater legitimacy than a candidate who is elected with 30-something percent, as is not uncommon in the UK at present. (In London, last week, 5 of the new MPs went through on less than 40%, the lowest being 32.8% for the Labour MP in Hampstead).
Following up on my blog on May 8, questions arose with respect to the minimum threshold. In my simulations, I assumed a 5% "hurdle" that parties have to clear to be represented in parliament. The reason for this hurdle is that otherwise a parliament would become fragmented and unworkable - past experiences in Italy and Israel are indicative (or think of Germany in the 1930s).
In practice this hurdle varies across countries. Turkey has a 10% hurdle, which keeps out quite a lot of voters - most notably the party of the Kurdish minority. Few outside Turkey would consider a 10% hurdle as fair. On the other extreme, Denmark has a hurdle of 2%, which results in eight parties in parliament. This works fine in Denmark: governments typically are minority coalition governments which agreements with other 'support parties'. Yet, I don't think this experience is transferable to other countries because Denmark has a rare cooperative political culture. Thus, most countries use 5%, while Sweden uses 4% - and this usually works well with three to five parties in parliament.
I had assumed in my simulation that a 5% hurdle be used in the UK, and it be applied separately for each region because of the peculiarities of Scotland, Wales and Northern Ireland. To prevent fragmentation of the parliament, it may be appropriate that the 5% hurdle applies to England as a whole. In the May 6th election, UKIP came closest to this hurdle with 3.1% across the UK.
If a 5% hurdle was applied for each of the eight regions within England separately, nothing would change. If the hurdle was lowered to 4% and applied separately for each region within England, then UKIP would jump over the hurdle in four regions and attain 10 seats, whereas the BNP jumps the hurdle in two regions and gets 4 seats. Obviously, an increase in small groups in parliament would make stable government more difficult, and an appropriate hurdle is necessary, preferably applied to the country as a whole.
In practice, voters are likely to vote differently under PR. The results from the European elections last June suggest that UKIP may well get more votes and pass the 5% hurdle, mainly at the expense of the Conservatives - and if they do they should also be in parliament. Also, the Greens are likely to gain more votes, mainly at the expense of the LibDems, though they would struggle to get over 5%. The BNP with their tiny but highly concentrated pockets of support are actually less likely get anywhere near parliament.
How would the UK Parliament look like under proportional representation? Using the numbers of actual votes on May 6 provided by the BBC for each region, I calculated the seats for each party.
Figure 1 shows the total number of seats for each of the main parties. For ease of presentation I did not separate out the Northern Ireland seats, and I aggregated Scottish National Party (SNP) and Plaid Cymru (PC).
Figure 2 shows the pattern of seats across the regions of the UK using PR.
Figure 3 shows, for comparison, the pattern of actual seats.
How I calculated these numbers:
In a follow-up investigation, I looked at the claim by the Conservatives that they need more votes on average per seat. It turns out this is true, but not by a huge margin. Two issues are at play:
I made some further adjustment by allocating seats to region proportionately (again using Hare-Niemeyer). Thus, Scotland (-4), Wales (-8), West Midlands (-2), Northern Ireland (-1) and Northeast (-1) loose seats, while seats are gained by Southeast (+6), East Midlands (+3), Eastern (+3), Southwest (+2) and London (+2). It results in a small change in the overall result for the main parties as the Conservatives gain 4 seats:
The missing election debate: Britain's future competitiveness
Politicians aiming to be elected in this week's election have offered view on seemingly aspects of British society and economy. Yet, one big debate is flatly missing: How can Britain compete in ten or twenty years time?
National competitiveness has been a major concern for policy makers and academics in most Western societies as they are concerned by new competition from - pick your favourite - Japan, Eastern Europe, China, India... The essence is that to secure the standards of living that we have in Western Europe today, we need to enhance our productivity. This requires investment today in resources and capabilities - in particular in human capital but also in infrastructure and in new technologies. Essentially, income is related to how much value people are able to add. The better the education levels, infrastructure and technology, the more value people can add in a society. People across Asia are heavily investing in education and training, and Europe cannot rely on its inherited wealth and human capital to sustain its position. No consensus exists how such investments should be motivated and financed, but complacency is not really an option. Thus, I am puzzled why in Britain, few seem to worry about this.
In the past decades, the British economy appeared (!) to do quite well compared to the rest of Europe. Thus, competitive threats were not felt as directly. However, the recent growth was based on a few factors that are not sustainable. Firstly, the financial sector makes an unusually large contribution to British GDP and (prior to 2007) to tax revenues. However, as the financial crash demonstrated that a lot of the value created in this sector is fictitious, and it comes with high economic risk. Secondly, the UK has been competing on the basis of - compared to continental Europe - low labour costs due to lower de facto minimum wages, less social security and the ease of firing people. In view of the rise of eastern Europe, China and India, it is unclear to me how a low-cost strategy may be viable in the long term (though the 25% devaluation of the pound in 2008 helps this strategy in the short run). Of course, there are other pockets of excellence (biotech, creative industries, tourism, universities), yet they are all small.
To maintain a high standards of living for large numbers of people, Britain need to invest into the education of its people! In particular, primary education and vocational training for those who do not go to university are fairly weak. The discrepancy between the well educated (who themselves (or their parents) usually have to pay quite a bit) and the lowly skilled is particularly large. These issues have been touched upon in the debates on education and the tax system. There have also been policy initiatives under the last government, but rarely backed up with substantial amounts of money. Moreover, the debate usually takes a social angle: isn't it unfair that ordinary people pay so much in taxes / for education. Yet, really, it is an economic problem. If Britain doesn't find a way to invest substantially more in its young people, it will not be able to keep a standard of living comparable with the rest of Europe!
I have been puzzled by this merger since it was announced a few days ago, but I have yet to find a good explanation in either the German or the British press. Die Bahn, Germany's state-owned rail operator, is taking over Arriva, a British bus and rail operator with subsidiaries across Europe. The most peculiar feature is that a company owned by the German taxpayers will in the future be running London commuter trains. How does that make sense?
Mergers and acquisitions can essentially be driven by three motives: (1) expected synergies - i.e. the two operations together are worth more than each separately, (2) managerial hubris in that the acquirers overestimate their ability to run the acquired firm better than the incumbent management, (3) managerial self-interest. On synergies, Die Bahn's CEO made a peculiar statement in the Handelsblatt "in the economic analysis, no synergy effects have been assumed". That is most peculiar because essentially all major mergers are, at least in public, explained by 'synergies'. Let's briefly reflect possible synergies:
Of course there may be more subtle benefits that escaped my attention. Yet, I can't see synergies, nor could I see how the management team of a moderately profitable state-company could run a highly profitable company better than its current owners to the extend that it would justify the premium paid for Arriva stock. This leaves managerial hubris and self-interest as most likely causes...
In German politics, we have seen a rare agreement: trade unions, Die Linke (a left-wing opposition party) as well as the F.D.P. (a free-market party in government) both criticized the deal in strong terms. The statement on synergies cited in Handesblatt made me especially worried: did they just add the two companies together and - voila - the joint company has a higher average profitability than Die Bahn prior to the merger? That can't possibly be! This leaves just one question: how and why has the supervisory board (Aufsichtsrat) has approved the deal: after all, politicians and business leaders are well represented in the board, along with the in Germany obligatory contingent of employee representatives. I remain puzzled.
The only conclusion I can offer is that British tax payers ought to be happy that someone else is providing them with basic services; and if a problem arises they can blame "the Germans" rather than having to work out themselves why British trains are running late again ...
British media has in recent week seen something of a revolution on how they discuss their election. Rather than discussing the likely "swing" between Labour and Conservatives, the debate is focusing on the actual percentages of votes that parties are likely to get. And with this Pandora box being opened, it becomes obvious to all but some stubborn politicians that the current system does a poor job in translating the voters will into power in the parliament. Thus, the debate on electoral reform is gaining pace (also see January 5). To the arguments raised in the media, I would like to add four points. These concerns the question who represents the respective parties in parliament:
Every year, the British Queen recognizes select companies for their outstanding performance. This year, one of the 'International Trade' awards went to the FA Premier League, the top division of English football. Surprised? You should not be!
The Premier League generate sales of £1 billion in 2009, of which $250 million were international sales, according to the FT. 90% of those international sales are broadcasting rights paid by TV companies (or their intermediaries) the world over for the right to broadcast English games. The biggest markets are reported as Southeast Asia (16%), Hong Kong (12% and Singapore (11%). The passion for English teams in that part of the world for the English game is amazing - I saw people in the street bars and restaurants of Hanoi and HCMC up in the middle of the night to watch Premiership life!
The Premiership shares many features of other successful British businesses: They are in the entertainment business, they have a lot of foreign owners (Chelsea, Man United, Liverpool, Man City, Birmingham etc), they have a lot of foreign managers (Wenger @ Arsenal, Ancelotti @ Chelsea, Mancini @ Man City, etc), and many of the star employees hail from all over the world (the list of top goalscorers read like the UN membership directory: Drogba, Tevez, Torres, Fabregas, Adebayor etc). The amalgam of people - a result of liberal immigration policy and a culturally diverse and tolerant society - are the foundation of their success.
Grand debates are braking out on whether or not the closure of the European airspace was excessive - did 'health and safety' folks go mad? Sadly, few commentators in the media seem to understand the science underlying the decision. The BBC broadcast a good programme yesterday that helped me understand the issues. Two important points:
The scientists interviewed on the programme suggested that the closure of the airspace as a precautionary measure was quite appropriate to the risk. As they are the experts, I can't argue with that.
However, there is a broader lesson here. I have argued several times in this blog that in a volatile global economy, a key capability for businesses is to react flexible to the unexpected, and to have alternative channels or supplier to deliver your goods or services. The current crisis suggest that we - and airlines in particular - are too dependent on the jet engine. Helicopters and propeller aircraft seem to be less sensitive to this sort of ash, but they do not have same speed, reach and capacity as jet aircraft. Finding alternative modes of transport (perhaps also with less emissions) should now be a major challenge for engineers around the world...
The UK has been leading in Europe in the development of budget air travel, both domestically and to holiday destinations. This is widely credited to the earlier deregulation, and hence greater competition, in the airline industry. However, there is another reason: the infrastructure for surface transportation - rail and motorways - is much less developed. In continental Europe, the railways are much faster, cheaper and more reliable, which makes the option to travel out of town to the airport, and then to fly, much less attractive. In the UK, Maggie Thatcher underinvested in infrastructure two decades ago - and that investment gap has never been made up by subsequent governments.
The UK's reliance on domestic air-travel has become more controversial with the increased awareness of global warming and the carbon footprint of air-travel. The closure of the UK air-space due to the the volcano eruption in Iceland caused unexpected disruptions of a different sort. This should focus politicians on modernizing the railways, and making them more affordable, to catch up with the standards in the rest of Europe. Sadly, though, with cash in short supply, it is unlikely that much will happen, and the UK's public infrastructure is likely to fall further behind.
The ability to react to unexpected disruptions in the supply chain is a crucial capability in international business of the 21st century. The past decade has seen a wide range of different disruptions, some man-made: terrorism, war, or trade sanctions. Others are events of nature such as earthquakes and taiphoons, the Asian tsunami, SARS and swine flu, or the eruption of the volcano in Island this week.
Businesses basically have two ways to respond: tell the customer that hey have no legal obligations because events are beyond their control, or they can go beyond their call of duty and help the customer. This week, airline customers experienced both sort of reactions. Some were left stranded at stopovers with nowhere to go and airlines providing little information and support. Others, couldn't get customers to their destination either, but showed respect and offered at least moral support, accommodation and food for their customers. Guess, whose customers will come back when the crisis is over, and who is going to bin their frequent flyer cards? Crisis are great opportunities for companies to show that care about their customers is not just an advertising slogan.
Budget airlines work with minimum service, and offering nothing more than exactly what was contracted - with no obligations to help even in case of minor disruptions. The trick of two single tickets instead of return tickets further reduced their obligations to help stranded customers. Those flying frequently finds that the real costs of budget airlines are just not worth the hassle. But also mainstream airlines have in recent year been "cutting slack" to save costs. That may not have had direct effects on services, but it reduced flexibility. Companies that have a bit of slack - and a motivated workforce - are much more able to react to crisis, and 'go the extra mile' to keep customers satisfied. Others, like British Airlines, have for years focused on (short-term) shareholder value by increasing efficiency, speak 'cut costs'. Consequently, a de-motivated workforce went on strike on Easter, and customers are disgruntled. BA will face an uphill struggle, even if the losses during the crisis don't bring them down.
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