Tuesday, August 10, 2010

Is New Zealand a rip-off?

(This blog is co-authored with my colleague Dr Debashis Bandyopadhyay. A version of this blog appeared as a perspectives article in the New Zealand Herald, Page A13, August 11, 2010)

In recent days there has been a lot of discussion about whether New Zealand is a “rip-off” following comments – no doubt well-meaning ones - made by a British columnist, later supported among others by our very own Justin Marshall. However, it is important to understand that there are actually two separate questions implicit in this one simple phrase.

First, is New Zealand a rip-off in the sense that our prices for day-to-day goods are higher than other countries even after you make the necessary corrections for differences in exchange rates? Second, and probably more importantly in the current context, are those prices high because of deliberate over-charging by producers? I would submit that the answer to the first question is most likely yes and the answer to the second is most likely no.

Let us start with the second question first. It is important to remember that the extent to which a producer has power over the price he charges depends on how competitive the market is. A producer can only charge high prices if there are no competitors available to undercut his price and lure customers away from him or if he can somehow or the other collude with his competitors in over-charging his customers. Because if a particular producer is making large profits, then it is most likely that another producer can come into the market, undercut his prices and still make enough profit to make such price cutting worthwhile.

This implies that in markets with vigorous competition and many small firms, it would be difficult to keep over-charging customers because there are enough other producers around who can and will undercut prices if it makes money to do so. And if there are a whole lot of competitors, colluding with all of them is a difficult proposition. This in turn most likely implies that – given the profusion of cafes around the city – we are most likely not paying too much for our daily dose of flat-white and those prices truly reflect the underlying costs with not much of a margin. A similar argument is probably applicable to hotel prices in popular tourist resorts.

How about fine dining? These markets are certainly not competitive and the issues here are somewhat different. Is $28 for an entrée in a restaurant in the Viaduct Harbour too much? There is no clear answer to this question. For those who are going there and enjoying the food along with the ambience and the view of the water, it most likely is not. Someone who is not willing to pay that price is surely not going to eat there. What the restaurant is clearly exploiting is their monopoly power arising out of their prime location. But the point here is that the restaurant is not primarily interested in the price it charges but rather in the profit it makes. It is most likely that the restaurant calculates that they can get away with charging $28 for an entrée and still enough people will line up to make it worth their while. Because if their profits would go up by charging lower prices they would surely do so!

Given that restaurants in the Viaduct Harbour or on top of the Skytower clearly enjoy the advantages of being in a premier location they are charging the prices that maximize their profit and it is difficult to see how one can increase competition in this regard in an attempt to lower those prices. So if the view and the setting are not worth that much to you then you should probably not patronize these establishments. It is also probably worthwhile to remember that these people also pay a premium on the rent for these locations.

Okay, so are there any situations where producers are deliberately over-charging? Yes, it is most likely that we are paying too much for our meat and produce at the local supermarket. It is one thing if we have to pay through the nose for exotic foreign goods that are shipped from a long distance away. But that does not explain why we pay top prices for locally grown meat, fruits and vegetables.

In the absence of hard data, one can make conjectures as to why this might be the case. In Auckland, the supermarkets are owned by one of two companies Woolworths and Foodstuffs. The extreme lack of competition in this market pretty much guarantees that the supermarkets can get away by charging high prices. It is also not unlikely that there is some amount of implicit collusion among these two companies.

However, before we condemn the supermarkets, there is one other issue that needs to be remembered. It is possible that our supermarkets also experience higher costs than would be true of supermarkets in other countries. We all know the price a producer charges is related to the underlying costs. For large supermarkets there are large fixed or set-up costs. It costs money to build and operate one of these stores. This cost is fixed in the sense that if you decide to build a large supermarket then you have to incur some of these costs in terms of building costs, the cost of air-conditioning etc. which is independent of the amount of goods that you sell.

Now the more you sell the less your costs become on average because this large fixed cost gets distributed over a larger volume of goods making each item less expensive to produce and sell on average. But the extent to which these average costs decrease depends on the volume of your sales. Here is the problem. Auckland – and New Zealand - is a very small market. And therefore it is possible that the sales volumes are just not large enough to give the producers adequate cost savings. So which view is correct? Are costs too high? Or are they deliberately over-charging given the lack of competition? Probably a bit of both. This is an open research question.

So, what is the average consumer to do? Well, it depends. How important to you is the convenience of buying everything under the same roof in air-conditioned comfort? How pressed are you for time? If you can spare the time, then drive to the nearest Chinese supermarket or farmers’ market. But this might mean having to make multiple stops for all the things you need during the week.

And how about romantic dinners? Summer is just around the corner. Pack a chilly-bin, grab a beach-mat, get in the car and drive to a scenic spot. We are lucky to live in a country where there are plenty of these in close proximity and they are all free!

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