State acts to root out ‘embezzled inflation’

Inflation is the economic indicator that will define the South African economy in 2013. Electricity and fuel prices are set to increase, the growing current account deficit will cause the rand to fluctuate on a devalued mean and increase the price of imports, and the decrease in manufacturing activity will put upward pressure on local prices.

In this context, consumers should warmly welcome President Jacob Zuma’s announcement to grant formal powers to the Competition Commission to engage in market inquiries as of April 1.

In economic theory there are two types of inflation: cost-push inflation, caused when the price of key inputs of production increase, leaving the producer no option but to pass these costs on to the consumer; and demand-pull inflation, when the growth of demand accelerates faster than the growth in supply, causing consumers to bargain up the price of available goods.

These factors are often a necessary evil of the market economy and a consequence of economic growth.

I propose a third: embezzled inflation, where firms alter the market to centralise power in their favour and allow them to inflate prices. There is no economic benefit from this inflation and it is the kind that Zuma, in this instance, is out to target.

In a market where there are no artificial barriers to competition, all firms should make a profit only high enough to incentivise them not to switch to another industry. If firms earn in excess of this, other firms enter the market to share in the profits, supply increases and prices fall. Where a firm earns less than this base level of profit, it will shut down or switch industries, increasing profit share for the remaining firms and re-establishing a stable market.

The kinds of excessive long-run profits earned by many South African firms is indicative that the competition mechanism has broken down and consumers are paying prices inflated far above acceptable market levels. The commission’s powers of market inquiry are to establish where and why this is taking place.

There are many ways firms can alter the market. The most blatant, and illegal, is active collusion with a competitor to either fix prices above a certain level, or to segment the market such that true competition does not take place. A common way that large firms legally get around this is by simply buying their competitor through mergers and acquisitions, although the commission is good at keeping an eye that this process does not go too far.

A more subversive way of strangling competitors is to force a loss-making situation and outlast them with deeper pockets. Starbucks used this to great effect by identifying a successful local coffee shop and opening three extra Starbucks stores in the same area. All four would make a loss but Starbucks had the resources to wait until the local store closed and then shut two of its own stores, leaving it as the sole coffee retailer in the neighbourhood.

Even firms that sell in highly competitive markets can engage in uncompetitive behaviour by controlling their suppliers. A retailer can force its supplier to sign an exclusivity contract disallowing them to simultaneously supply anyone else, and thus affect the competitiveness of its rival.

A certain level of inflation is necessary and inevitable and caused by factors far beyond the South African economy. But a large portion is not and it is promising to see the government taking active steps to address the problems that lie domestically.

Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision-Making course. Follow him on Twitter @PierreHeistein.