Competition - something to create benefits, not a benefit in itself
by Matthew Cherry, Chief Economist, PSR
Since the 1980s, economic regulation has focused on the idea of promoting new competition as a way to deliver efficiency, to make the best use of the economy’s scarce resources between all the competing uses for now and the future. That means that competition is not a goal or benefit in itself, but rather a tool used to create benefits to consumers.
But how does a regulator use this tool in the real world? What are the limits to what can be achieved with competition?
The roots of the current systems of economic regulation can be traced back to the 1980s and the approaches put in place for the monopoly businesses which were privatised at that time. This started with developing the approach to regulating BT, one of the first major privatisations. This approach considered the setting of price controls for monopoly elements as something to stand in for competition as it was developed. Promoting new competition, as opposed to – and in addition to - protecting competition through the antitrust rules, has since been at the heart of economic regulation.
The reason for this is that competition - rivalry between suppliers – creates good outcomes for consumers. If one firm tries to charge too great a margin (too high a price) then other firms will compete, likely by undercutting the price. Consumers all switch to the better value firm and the firm charging higher prices ultimately needs to cut these to a more competitive level to avoid losing business. A similar logic applies to other dimensions: a firm which does not innovate sufficiently will be left behind by its competitors, and a firm which scrimps on quality will find its customers voting with their feet and going to the firms with more appropriate levels of quality. More formally, economists say that competitive markets deliver efficiency: making the best use of the economy’s scarce resources between all the competing uses. That is, the process described above means that consumers choose the products they value most, leading to the firms providing those products being pushed to use the optimum combination of employees’ skills and materials which best delivers them. Otherwise there will be another firm – a competitor – willing and able to step up and provide that value in a better way, which overall results in consumers getting the package of stuff they value most from what markets can feasibly provide.
The essence of competition is therefore rivalry between suppliers, where purchasers have the option to switch - the straightforward textbook description of competition is a situation of many suppliers and purchasers but this is a simplistic short hand. “Many suppliers” conveys the idea of suppliers not being able individually to influence the price set by the market – and having many suppliers who must take account of the prices set by competitors is often, but not always, the way this is practically achieved.
Economic regulators such as the PSR therefore have objectives, set by statute, to promote effective competition as an important way to achieve the positive outcomes which consumers care about: efficiently low prices, appropriate quality choices and innovation in the longer term.
It is inherent in this narrative that competition is not an end in itself but an important tool which deliver benefits – good outcomes in terms of prices which are low (but high enough to allow businesses to recover suitable costs), where valued and valuable innovation is delivered, and consumers are happy with the available trade-offs between different prices and quality. Choice in this context is more subtle than simply having alternative suppliers, rather it is about being able to get the price and quality mix which consumers value.
So regulators should be promoting effective competition as a way of achieving these good outcomes for consumers, businesses and the economy as a whole and while this will often mean more suppliers, it may not always be just a case of more is better. Sufficient rivalry can in some circumstances be provided by only a few suppliers. There are also situations where more competition is not possible – often described as natural monopoly – essentially where it is inefficient to have more than one set of the relevant capital or infrastructure needed to deliver a particular set of outputs. This happens where the infrastructure required is extensive and expensive compared to the total number of users. For example, rail tracks between towns.
Economic regulators in other sectors have tended to introduce competition to particular areas or markets, or specific parts of the supply chain whenever there were benefits to doing so. In each of water, telecoms and electricity at different times since privatisation competition has been facilitated or promoted for different areas of the supply chains for those industries, different geographic areas or different customer groups (e.g. business versus residential).
Regulators have also tended to look for where introducing competition can provide the most immediate benefit and where the costs and benefits justify greater competition in terms of the positive outcomes it can provide. Over time, this can lead to the benefits of competition being provided across increasingly more of the supply chain. This can occur as firms are able to build up their investment, revenue and customer base within the sector and expand further up and down the supply chain (sometimes referred to as the ladder of investment). Another way in which the amount of the supply chain open to competition can increase is as technology changes over time.
Both of these factors have been important in introducing greater competition across the supply of telecoms services over the course of the thirty plus years since the original privatisation. Before 1984 BT controlled all the telecoms network, the equipment in customers’ homes, and the services which were provided over that. Over time, more and more successive areas where exposed to competition – with regulatory oversight – leading to the situation today where Ofcom expects there to be multiple full infrastructure providers over a large swathe of the country and few customers remember the days when the telephones themselves were only rented from the incumbent.
Services which involve two sided markets can also create specific challenges for promoting competition – as discussed further in another of the blogs the PSR has published today.
So, in promoting competition, regulators need to look for where competition can provide benefits to consumers. In payments terms, this is those making and receiving payments. This is therefore about more than just ensuring that ever more firms are able to provide payments services, but rather about ensuring that the process of competition delivers net benefits to those payers and payees. Competition is a process which delivers benefits and the important thing is to protect the process itself rather than individual participants within that process.
Another implication of this is that, especially in regulated sectors with issues around complex supply chains, cost structures which differ across those supply chains and two-sided markets, competition may (a) not be sufficient on its own and (b) need help from the regulator to ensure different firms have a level playing field (and what is “level” between incumbent and new entrant firms can be a complex problem in itself). Competition may not be sufficient in itself where certain vulnerable groups of consumers cannot access the benefits available to greater majority. Similarly, competition may not deliver an outcome which benefits all consumers in the long run when this is only achievable through co-ordinated action and where the average benefits across all consumers are relatively small but very significant for certain individuals.
The PSR’s work to date has addressed these kinds of issues and situations like this are likely to continue to arise in payments. One situation where "leaving it to the market” could lead to specific vulnerable groups being left behind is our work on access to cash. The work leading to requiring the implementation of Confirmation of Payee is a situation where co-ordination and a mismatch between average and individual benefits occurred. Regulation can also assist the process of competition work effectively, such as our Specific Directions 1 and 7 on indirect access to payment systems. General Directions 2 and 4 supports access to payment systems and ensuring payment systems take account of customer needs which all support competition further down the supply chain.
Our statutory duty to promote effective competition is where it is in the interests of those who use, or are likely to use, service provided by payment systems: this is entirely consistent with the economic ideas I have discussed above that competition is not an end in itself but something which delivers good outcomes for - in our case - those making and receiving payments. Promoting competition can raise complex issues in how it can lead to benefits which are the ultimate objective and regulatory interventions can be needed to ensure realisation of the full benefits of competition.
Going forward, where is greater competition needed in what elements of the payments supply chain to deliver the most benefits to end users? And how is the best provided (at what level of the supply chain)? And what (further) regulatory actions, or complementary regulations, are needed to ensure that such competition works to the benefits of all those paying and taking payments, including the vulnerable?
Matthew Cherry is the Chief Economist at the Payment Systems Regulator. The views, thoughts and opinions expressed in this blog are his own and do not necessarily represent those of the Payment Systems Regulator.