(This essay was published in Hong Kong Economic Journal on 9 January 2013)
The new Competition Ordinance, which was approved by the Legislative Council last year, is supposed to promote market competition. But can it solve two current problems that have arisen from a lack of competition?
In the first case, the wholesale price of Mainland beef has increased by 30% in the past year. Ng Fung Hong is the sole distributor of Mainland beef. This monopoly arrangement has come under public criticism. Beef merchants are urging the government to open the wholesale market to allow competition. The government promises to investigate and see whether the problem is the result of having only one distributor so there is no competition, or whether the supply of beef cannot keep up with demand on the Mainland and in Hong Kong.
The government further promises, “We will find out how the cattle supply chain on the Mainland works and how elastic the market is to see whether introducing competition at the wholesale level would increase the supply and lower the prices.” For a government that is keen to enact a bill to promote competition, one has to ask – shouldn’t it know the answer already? Hasn’t it already investigated this issue?
Any government keen to promote competition should be pro-actively conducting investigations into every industry to determine if more licenses could be issued or whether free entry should be introduced. Since the wholesale market for Mainland beef has only a single local distributor so it should have been an obvious candidate for investigation some time ago.
After all the government has licensed many importers of rice ever since it introduced licensing to the rice importing business in 1955. It seems strange that with only a single distributor in the local wholesale market for Mainland beef, such an investigation has never been conducted.
The Mainland has many suppliers of beef and Hong Kong is one of many demanders in that market. Unless there had been a consolidation in the distribution of beef on the Mainland in the past year, which was not the case, the price of beef should have risen only when the demand grew faster than the supply. However, in the case against Ng Fung Hong the argument is that as the monopoly distributor of beef, it has caused prices to rise higher than they would have in a competitive market, regardless of whether demand outstripped supply. This is chiefly an issue of competition.
How would our new Competition Ordinance deal with this case? It would do nothing.
The second case, also much discussed, is the government’s handling of free to air television. Hope for change in this area emerged three years ago when three newcomers formally filed bids to set up stations. One bidder intends to offer up to 30 channels within six years, outnumbering the dozen currently provided by the two terrestrial broadcasters. But the government has still not made a decision, even though the former Broadcasting Authority cleared the applications for consideration by the Executive Council long ago.
The government claims to be pro-competition and says it will follow public interest when deciding on the licensing. But this policy is empty if no decision is ever made. An unreasonably long process inevitably arouses speculation that other considerations are at work because otherwise, why can a timely decision not be made?
Hong Kong has had only two licensed stations for more than three decades. Meanwhile, the economy and the population have grown by leaps and bounds and digital and media technology have exploded. Common sense would dictate that on purely economic grounds the demand for more stations and channels must be present. Moreover, the stations would naturally sell services and products to tap an overseas market that has also experienced quantum growth in the past three decades. The government’s restrictive regulation on entry is the only stumbling block that is preventing the industry from becoming more vibrant and competitive.
How would our new Competition Ordinance deal with this case? Again, it would do nothing.
Limits of Competition Law
While our Competition Ordinance deals with some of the issues that were identified long ago by advocates of competition, the government’s policy on competition continue to fall down in some very important respects. To understand why, it helps first to understand the argument for competition.
The great capitalist engine described by Adam Smith, Karl Marx, Joseph Schumpeter and Milton Friedman thrives on market competition. Entrepreneurs strive to produce better and newer products through innovation by competing against other entrepreneurs in the market. This is hard work. The consumer is the beneficiary of this process. Moreover, the consumer also plays the role of the judge in determining which entrepreneur is the winner. Like the voter, the consumer is not easy to please.
There are two classes of activities the entrepreneur tries to work within to make his life in the competitive market place a little easier. First, he can conspire with fellow businessman to raise prices by reducing output. Adam Smith warned of this danger in his Wealth of Nations in 1776. Such conspiracies are known as cartelization. Cartels can come in many different forms, for example, mergers and acquisitions, bid rigging, market sharing, and so on.
Second, he can seek the assistance of government to restrict entry through either legislation or public regulation, and thus create a less competitive market environment. Such restrictions come in many different guises. The more obvious ones are monopoly franchises, licenses, import quotas. The less obvious ones include restrictions on advertisements that favor incumbent operators, and requirements to observe various occupational, health, safety, environmental and security standards that favor larger operators.
The Competition Ordinance deals to some extent with the first class of activities, but not with the second class.
Barriers to Competition
In previous articles (HKEJ 2011.1.19 and 2012.1.26) I have analyzed why the first class of activities are not important and certainly not important for Hong Kong. To begin with cartels are unstable. Keeping a business cartel together is challenging. Backstabbing and betrayal are common among business cartels and difficult to prevent or avoid. Tricks and devices that can hold a cartel together in one situation may not work in another. The market process is dynamic and continuously changing. Advances in economic and technological conditions attract new challengers who may not be successfully brought into the cartel. More importantly, innovative firms may offer new products that wipe out old cartels.
I have observed that politicians and lawyers who seek to regulate the process of market competition through legislation have misunderstood the economic theory of competition. They only see the static textbook model, but fail to appreciate the dynamic quality of the market process driven by entrepreneurial innovation, as emphasized by the Austrian economists Hayek, Mises, and Schumpeter. Competition laws do more to harm competition than promote it.
In Hong Kong, the real threat to a competitive environment has always been the second class of activities. The government is involved in an incredibly large array of regulatory activities that by and large create a less competitive environment in Hong Kong by setting up barriers to entry. Some of these barriers directly restrict the number of players in the market; others impose restrictions that favor incumbents over new entrants.
Hong Kong has performed well economically in the past sixty years despite such regulations because it could rely upon those industries that could successfully export their goods and services to overseas markets. These industries, for example, manufacturing, were naturally competitive because they had to operate in a highly competitive environment in the world market. As these export sectors have become relatively smaller, the regulatory environment has become a larger problem.
Regulation is also one of the reasons why many in Hong Kong complain about the lack of quality new jobs. The restrictive regulatory environment impacts not only production destined for the domestic market, but also the creation of new services and products that could be exported. For example, free to air television stations would create products that could be exported to overseas markets and create more quality jobs in Hong Kong.
This would support the government’s declared policy of promoting new creative industries. What could be more obvious than removing the barriers that have limited entry into the free to air television industry? Our own experience with liberalizing the telecommunications industry provides a vivid illustration of the enormous economic gains that can be had from competition. Experience everywhere shows that there are also many potential spillover effects from harnessing the benefits of digital convergence and content creation if only we allow our industries to become more open and competitive.
Similarly, lifting the barriers to entry in the distribution of imported Mainland beef would have wider benefits beyond beef because it would enhance opportunities for Hong Kong businesses to learn about supply chains on the Mainland, whether in beef or other areas. It would create more opportunities for different Hong Kong companies to accumulate knowledge of the Mainland market and eventually penetrate it more successfully. The Cooperative Economic Partnership Arrangement merely provided a key to the Mainland market, but unlocking the door still requires entrepreneurs to put in effort. What the Hong Kong government can productively do is to avoid gating another door.
The Power of Liberalizing Information
In sectors where there are large economies of scale, a necessary condition for innovation and competition to occur is to set up the basic infrastructure. For example, there are the distribution networks in the electricity and gas industry and the cable networks and airwave spectrum in the telecommunications and digital media industry. Information databases are an important source of these large economies of scale. Government can also play an important role in opening up these infrastructures to convenient public access and lowering the barriers of entry into new industries, thus encouraging competition.
Consider the benefits of information databases in the hugely successful story of the transformation of the real estate agency business. Thirty years ago this business was dominated by independent local neighborhood shops. Centaline and Midland were established during this era and they soon revolutionized the whole industry to become two of the most successful companies in the industry.
I am sure there are many secrets behind their success, but I shall focus on one issue and that is the creative use they have made of their database on properties and clients. They were among the first to recognize the enormous potential of developing a database of properties, which included histories of the previous transactions and attributes of the units, including neighborhood attributes.
They were soon able to link up their database on property transactions history with a database on the transactions habits of their clients. This allowed them to develop a more pro-active customized marketing strategy to reach out to these clients on a regular basis. The outcome of that marketing outreach would then be entered into the continuously growing and updated database.
Each neighborhood branch was no longer a standalone independent operator, but part of a larger networked organization that shared information and made client referrals. The creative use of databases allowed these branches to take advantage of large economies of scale to build a more productive growing business. Today Centaline and Midland dominate the industry and have expanded into the Mainland.
The government can help support the growth of creative approaches to business by opening up its vast amount of databases for public access (subject of course to the Privacy Ordinance) thus promoting competition. One example that comes to mind is the hospital records of the Hospital Authority. Without such data it is impossible to build an insurance market based on genuine information; the healthcare insurance market forever remains an industry of sales persons. With the data, Hong Kong insurers would have an opportunity to learn how to harness the information and create real quality opportunities and markets.
The power of big data in sparking new business is not a fad, but a pressing need if Hong Kong is to avoid running out of quality jobs. Private business is increasingly making good use of the transactions data they sit on; the public sector is lagging behind. Providing data in a convenient form is an enabling approach to supporting industry, and it is an appropriate role for government to perform. Targeting and selecting industries is not something government can normally do well. By making data more freely available, the government can leave this task to the competitive market.
Aims of Competition
More than twenty years ago I believed with the opening of China a third wave of new industries driven by the demand for health care and education would contribute to the economic prospects of Hong Kong. The first wave was spearheaded by manufacturing and trade services and the second wave by financial industries (including accounting, real estate, business and legal services). I focused on the demand side prospect at that time.
The economic prospects for healthcare growth is especially promising given the ageing of the local and Mainland populations in the next thirty years. There is both immediate domestic and Mainland demand for healthcare. In education, the demand for tertiary education is also growing rapidly on the Mainland and Hong Kong is an ideal location to tap this market.
Over time I have become more skeptical of these prospects because these industries face challenges to their competitiveness, in terms of opening up the supply side, lifting the barriers to occupational entry in health care, and providing land for building healthcare and education premises. When government declared some years ago that these two sectors could be pillar industries I was rather unconvinced anything would come of it. And what do you know, little has come of it to date. But it is working in the other direction. Already the Baptist University and Chinese University are operating universities across the border in Zhuhai and Shenzhen; and the University of Hong Kong is operating a hospital in Shenzhen.
The purpose of a competition policy is to promote a more vibrant market so that more economic activities are encouraged, especially innovation. The purpose of a competition bill should not be to penalize existing businesses and increase their cost of doing business. Will government policy focus on lowering barriers to entry, please?
Y C R Wong, “What a Competition Bill Cannot Do (Part One)”, Hong Kong Economic Journal, 19 January 2011. (www.wangyujian.com)
Y C R Wong, “What a Competition Bill Cannot Do (Part Two)”, Hong Kong Economic Journal, 26 January 2011. (www.wangyujian.com)