Thursday, 31 October 2013

Competition drives up insurance costs

The UK Competition Commission is investigating the vehicle insurance market, where costs are getting out of control as the Economist's chart shows.
The accompanying article notes in puzzlement that "competition abounds". So what is going on?

The UKCC's issues paper(pdf) suggested that the industry is arranged in an excessively competitive way. Apparently when your car collides with another in the UK, one of the insurance companies ends up paying for both cars. I think its the same here in NZ.

That structure gives the other insurance company an opportunity to raise its rivals' costs by getting an expensive repair job, and loading it up with generous terms for temporary replacement car hire, plus high write-off values so you're more likely to get a new car.

Its not theoretically clear how competition would play out given that market structure - maybe the firms could converge on an implicit deal to economise on repair costs irrespective of who pays. But cartel instability theory suggests that each insurer would be tempted to renege on any such deal, and that everyone might end with higher costs.

That latter story of cartel instability seems to be the UKCC's view. Investigation evidence led it to put the liability/control split at the top of its list of problems in July, and now the Economist reports that insurers are welcoming the prospect of regulation to stop them from competing in this way.

The prospect of rivals welcoming regulations that inhibit competition would normally chill me to the bone, but this one sounds like it could work.

Wednesday, 30 October 2013

Will Washington do it again?

Last year, Washington State became the first (jointly with Colorado) to legalise marijuana. They did it through an election in which 81% of those eligible voted. While the proposal was radical in an historic sense, the war on drugs has become something of an embarrassment even to the US authorities, and with respected newspapers like the Economist advocating legalisation then perhaps it was only a matter of time.

Another year, another interesting ballot proposal in Washington. This time it is to require labels that acknowledge the presence of GMOs in food which is already nutritionally labelled. The vote is next week, on Guy Fawkes day.

Unlike the marijuana issue, this time there are seriously annoyed corporates opposing the move. They have collectively tipped in over $20m of campaign funding. If you want a sense of how pervasive GMOs are in those United States, read the list of contributors and their brands.

Those promoting the move are characterising it as a fight between locals (consumers & farmers) vs big out-of-state business, and their myth-busting fact sheet(pdf) gives an insight into the way the the issues are being presented to voters. Samples myths include:

  • Trial Lawyers Will Sue Farmers If It Passes
  • Shoppers Will Pay More For Groceries
  • It Would Cost Taxpayers Millions 
From an economic standpoint, the benefits of GMO labelling come from giving consumers relevant information, which is a basic requirement for market efficiency. Offsetting those benefits, the direct costs of GMO labelling are surely quite low. Food manufacturers often change their labels so if you allow a reasonable transition time to GMO labelling it'd be hard to argue with the idea on a direct cost basis.

I doubt that the GMO sellers are genuinely afraid of the direct costs. Its the indirect costs that will scare them. These will come from the market reactions of better-informed consumers who try to avoid food with GMO content. Oh, and don't forget the slippery slope: if this gets up in Washington it could break the spell and other states might do the same thing.

Wednesday, 23 October 2013

Learning or returning?

The idea that NZ's agriculture industry should learn from the past has cropped up a bit recently. Agknowledge is clearly arguing for more emphasis on legumes for example. And according to Jacqueline Rowarth in the latest Rural News (not online yet) "winding back the clock 20 years to save New Zealand land and water" was promoted at a recent resource management law conference. She thinks it's a bad idea and does her usual myth busting thing, praising "technology", slagging off raw milk and claiming that "the dominant imperative now is cheap food from a well managed environment.....winding back the clock is not the answer". 

What interests me is Jacqueline's focus on returning to the past, rather than learning from it. That sets up a false dichotomy and implicitly assumes that newer is always better. Pretty disappointing attitude from an academic, but maybe this is what happens when business dominates science: technology becomes redefined as something you can sell. Ironic also that this should coincide with the Economist's highly critical analysis of modern science. 

Monday, 21 October 2013

Jon Morgan begs a great question

Jon Morgan's opinion piece in this week's Straight Furrow is titled "Real science is money well spent". Amen to that.

He distinguishes real science from the fringe which he defines as
"psuedo-science - the dissemination of half-truths and wishful thinking, sometimes based on poor research and incomplete trials.
Some people prefer psuedo-science. They're the antis, the ones who refuse to let the scientific facts shake them from their entrenched bigotry. They scout around for science to back them up, and when they find it, cling to it desperately without questioning its veracity.
I put campaigners against fluoride and 1080 in this camp. You can probably think of others.
Then there's a third category. This is where the scientists can't agree, where there's still doubt. I'd put climate change in this group. Others could be genetic modification and biological farming, though mainstream science seems to be swinging towards the former and against the latter."
By opining like this on where "real" science is pointing, Jon is revealing the frequent absence of a bright line between real and psuedo science. This makes it a classic text for me.

Take the 1080 point for example. There is surely no blanket case for 1080 - it must depend on lots of things that vary by location. I doubt we'll see it in Cornwall Park or Hagley Park for example. So the "antis" are right in some places even according to "real" science. Constructive engagement with opponents is therefore appropriate, rather than assuming "entrenched bigotry" .

Jon's final sentence is the real gem though. I love how it elevates biological farming to a (the?) challenger in an epic battle against genetic modification, only to slur it with a withering inference from "mainstream science". How did he form that view? Was the volume of work influential at all?

It seems to me that far more resources are being invested in scientific work on genetic modification than biological farming. GE attracts investment because it can be monetised whereas biological farming is more like a general purpose technology, a public good in which the market will under-invest.

So I wonder whether Jon has perhaps been swayed by the volume of work on GE and the big-money hype about it, and forgotten or not noticed the absence of any serious comparative analysis of GE and biological farming as alternative future visions for New Zealand's primary sector.

Still, by getting the idea out there he has exposed a question that needs to be answered. Does biological farming have the potential to materially improve agricultural productivity in New Zealand? If our future really does involve a choice between GE and biological farming, then "real" scientific work is obviously needed on this question.

Friday, 18 October 2013

Competition matters

The Commerce Commission’s conference was very good. There was a much bigger crowd than at the CLPINZ workshop in August, and with correspondingly less scope for interaction & discussion - a congestion effect. But the Commission pulled in a strong group of international speakers which was enough compensation for me. Two sessions were particularly interesting.

Firstly, there seemed to be agreement that “something” needs to be done about s36 of the Commerce Act. That section prohibits the taking advantage of substantial market power to reduce competition. It is the primary constraint on powerful firms in NZ and has been totally ineffective for a few years, largely because the Commission believes it is ineffective. When the main prosecutor is disillusioned with the law, you either have to reillusion them, so to speak, or change the law.

Andrew Gavil deconstructed s36 beautifully, exposing the logical error that has emerged through our case law and explaining how it can easily result in false negatives (i.e. wrongly exonerating anti-competitive conduct). The case law has established a “counterfactual test” as being necessary to prove a claim that s36 has been breached. This test can be framed in different ways but it basically asks whether a firm that lacked market power would or could have acted in a similar way. If so, then the claim fails. If a firm without market power would or could do something, then market power is not needed to do it.

The false negatives come from situations where certain conduct (e.g. exclusive dealing) would be pro-competitive if done by a small firm but anti-competitive if done by a firm with market power. 

The logical error Gavil argued is that “taking advantage” implies that the firm gains something from the conduct, such as a weakening of competition. But that question is largely irrelevant to s36 analysis under the counterfactual test our case law has created. Instead, we end up focusing entirely on the motivations and incentives of a completely hypothetical firm: one that lacks market power but otherwise looks like the defendant firm.

Solutions are harder of course, but I think it is now inevitable that we need to rethink what is going on here, and the sooner we get started on that, the better.

The second session of interest to me was called “the future of telco markets”. Italian professor Carlo Gambini gave a nice overview of the economic issues. He included the well-known fact that technology is converging to the point that one misses a lot unless we think about telecommunications, broadcasting and internet services wholistically.

A single high capacity network can now supply voice call services, internet browsing, skype calls, television and video-on-demand. That means we are heading for a world in which competition will be in bundles of services. We are already seeing this kind of thing in NZ. Soon, firms that can’t compete with complete bundles like this will become marginalised.

The other theme from the “telco” session was that value and profits are moving upstream to content providers. Network providers, particularly in the mobile sector, will get squeezed between paying for a technological arms race driven by advancing technology (2G, 3G, 4G etc) and the content suppliers who capture the bulk of advertising revenue. That is already leading to some infrastructure sharing between mobile networks, a trend that is expected to continue. It may also lead to mergers and therefore less competition between networks. 

I wonder how that is going to shake out in NZ, where our mobile sector has only recently been shaken up by the arrival of 2degrees, which is struggling. Are we heading for a world where the sustainable structure of the mobile industry is one strong physical network that stays on the best-practice upgrade path, and competing retailers having open access to that network?

Wednesday, 9 October 2013

The urea business

Before the Maui gas field was discovered, NZ farmers mostly got nitrogen into their pastures by using legumes such as clover to suck it out of the air, which is 78% nitrogen.

Maui was such a large gas field that new industry was needed to make it financially viable. That need was fed into a "think big" programme and out popped a new ammonia-urea plant in 1983.

I'm not sure what happened to all the urea initially (maybe some was exported?), but eventually the push to sell urea started winning over farmers and sales grew very strongly through the 90s, as the graph shows.
My hypothesis is that a surge in paid research into the benefits of urea pre-dated the surge in usage. Sometime I'll dredge NZ's agricultural science literature to properly test this, but meantime here is some anecdotal evidence from the NZ Journal of Agricultural Research. In its first year of publication (1958) it looked like a biological farmer's dream, with eleven separate papers on "biological studies of some tussock grasslands", work on honey bees including the effect of defoliants on bees, a fair bit on trace elements and phosphatic fertilisers, but nothing on nitrogen. Scroll through to 1983 and there are three papers evaluating nitrogen as a fertiliser.  

It seems pretty obvious that the huge change in grass-growing methods through the 90s was pushed by the suppliers. We had an embarrassing volume of gas so a urea plant seemed like a good idea. That led to an embarrassing volume of urea. So work started on explaining to farmers the benefits of urea. And that work has never stopped, which is why on the DairyNZ website there are now 65 references to urea for every reference to legume.

So the profits available from urea are a major reason reason we use so much. How profitable is it? Well, today's price is $640/tonne (well down from a year ago). The energy data file reports the price of gas to industrial users as being around $8/GJ. Using this calculator and converting $NZ/US at 83c, we can deduce that the production cost of urea is $264/Tonne. That's a pretty fat margin and a great incentive for urea sellers.

Meanwhile, internationally, it has been argued that a cartel has been operating in the fertiliser industry, but has recently been disrupted by China and India using single buyer policies. NZ is connected to world prices for urea because we use more than our plant can produce. Ballance owns the plant, but Ravensdown is a big importer of urea. Imports have allowed Ballance to keep earning massive margins: their price just needs to stay at a level that can't be undercut too much by importers. But they need to allow some scope for imports to avoid regulatory attention.

The bottom line is that kiwi farmers have been sold a different way of farming because it is profitable for fertiliser sellers. That's the reason we use so much urea, and the reason that alternative and apparently much cheaper methods like promoting legumes and soil biology are not being researched.

Tuesday, 8 October 2013

Roundup roundup

This is an update on the previous post.

Is it actually happening? Yes, I have reports in from several people who have seen sprayed silage being harvested, in Waikato, BoP and Taranaki. So the Nufarm marketing is working. Apparently not in our area (top of the south island) but I would not be surprised if it was happening in the bigger dairying regions of Canterbury & Southland. Please drop me a line if you know if it.

Are other people appalled? Yes, generally (but see below). Everyone I've spoken with who has offered an opinion is staggered that firms like Nufarm could be so silly and the farmers so gullible. So far, no-one has tried to praise the concept.

Do the authorities know? Fonterra knows, as does MPI. I dealt with the communications/pr/media people at these organisations on the assumption that if anyone could sense a scandal risk it'd be them.

Do they care? No idea. I was hoping they'd be on the job promptly, condemning the practice and trying to shut it down. So far I haven't even got clear statements from either Fonterra or MPI that they disapprove. I think this issue is a tricky one for them, being so fully committed to "scientific" agriculture. Pulling the plug on a use of Roundup might be seen as breaking ranks, and the thin edge of a wedge.

Meantime, in case any of you are still of the view that Roundup is OK, have a read of this from Professor Don Huber who ran Monsanto's research programme at Purdue University for many years.

Saturday, 5 October 2013

Silage a-la-Roundup

Kiwi farmers are not well served by their chemical suppliers. Here's an example.

NufarmPGG and probably others are pushing a new use for Roundup. It goes like this.
  1. Grow a really nice paddock of lush grass, far too much for your stock to eat immediately, with the aim of fermenting it into silage for feeding out later. But instead of just cutting, chopping & storing as usual, you use this new system
  2. Spray it with Roundup or equivalent
  3. Wait for your crop to die
  4. Cut, chop, store as normal for silage/baleage
  5. Feed to your animals
I am not making this up. They really do advise farmers to do this. Look, here's the sales pitch (pdf).

Would you knowingly drink milk from cows that eat this food?

Update 11 October 2013
Nufarm have advised by email  that

  • Every year in NZ over 200,000 ha of pasture is treated with glyphosate and then either grazed by animals within 3-7 days or cut for silage and fed to animals at a later date.
  • There is no withholding period. The label recommends not feeding for 3-7 days but you can if you want.
  • A number of animal feeding studies have been done around the world regarding this use for glyphosate. None show any safety issues but none have been published. Trust us on this. 
  • Confidential data was provided to EPA and ACVM (the regulatory bodies in NZ) to get approval for no stock with-holding period.
So there you have it. Its a very widespread practice and they think its perfectly safe.

Thursday, 3 October 2013

Is insurance a natural monopoly?

From this distance, its hard to fathom the intense hatred Republican congresspeople must have towards the new health insurance scheme in those united states. I keep thinking there must either be some complex political games in play or they are raving mad, but maybe its both.

Anyway, the plan to get lots more people into a risk pool and thereby drive down premiums has got me thinking about a question I was asked earlier in the year at one of our short courses. Is insurance a natural monopoly?

The basic economic function of insurance is to pool risk. The resulting diversification reduces risk for each insured person. It seems to follow intuitively that it might always be beneficial to have more individuals in your risk pool. (Obviously if you know for sure that someone is very high risk you'd prefer to exclude them, but these things cannot be predicted with certainty.)

Another pointer towards lower costs with a bigger risk pool is the fact that some many large firms carry their own vehicle insurance.

So in a static sense, it might well be the case that certain insurance markets are natural monopolies, meaning that the lowest cost of supply is through a single firm. That view omits some feedback effects though, such as:

  • the potential for a monopolist, free from the pressure of competition, to allow internal administrative costs to rise; and
  • whether a monopolist would feel the need to invest in claim cost management (eg helping to prevent accidents and deal with them cost effectively).

That makes the question an empirical one. The experience of Switzerland and Germany in the 90s is interesting in this regard. Von Urgen-Sternberg (pdf) (cool name!) compared comparable insurance products between regions with state-run housing insurance monopolies and those with competitive markets, and found the former had 40% cheaper premiums, invested more in fire prevention and had substantially lower damage rates.

Part of the reason was that selling costs were much lower (no advertising) but also the competitive firms were somewhat more lenient on payouts for fear of losing customers.

There is certainly a lot more to think about here, but on the principle that there is nothing so nice as an interesting question, this one is worth sharing around.