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Forces for courses

23 March 2015 By Edward Hadas

The competitive markets of traditional capitalism help make modern economies successful. But they cannot do everything.

The UK grocery business provides an excellent example of market forces working well. For many years, the industry was led by Tesco, the largest and most efficient operator. It set prices high enough to earn about a 15 percent return on capital employed. The smaller competitors worked hard to keep up. But until about two or three years ago, the rivalry seemed well balanced.

There was little sign that outsiders would pose a meaningful challenge and the incumbents all had roughly the same strategic priorities. They strove to open as many big shops as they could while increasing the range of product lines. Some entered financial services. With varying degrees of success, they built online sales channels and chains of smaller convenience stores.

The market almost looked rigged, and some protesters claimed it was. But if that were the case, the industry would have failed to embrace innovations and become less competitive. Shareholders may have done relatively well. Customers would have fared badly.

It hasn’t gone like that. Aldi and Lidl, two new-ish well-funded entrants, have shaken the industry. They started selling groceries for less. If the industry really was rigged, the incumbents would have found ways to block the rise of the discounters, say, by impeding their access to wholesalers. Instead, they responded by lowering prices, as the theory of markets says they should.

When online shopping proved unexpectedly popular, the British incumbents were equally market-friendly. They did not call for strangling new regulations of drivers, delivery vehicles or product quality. They did not try to block Ocado, a well-funded online-only startup. On the contrary, one of them, Waitrose, signed up to help.

As a result, British shoppers are getting better prices and better service while shareholders get dividend cuts and stock price underperformance. That is how it should be in a well-functioning capitalist system. Keen competition combined with innovation and ambitious entrepreneurship creates new winners, new losers, and new improvements in lifestyles.

Even so, market forces can never succeed in isolation. To work, they need supporting social and commercial infrastructure. The prerequisites for success include a strong work ethic, sound financial and educational systems, helpful governments, competent research institutions, the rule of law, reasonably effective regulators and a social consensus that works in their favour. As Russians and many others have painfully discovered, markets bereft of these supports can be economically disastrous.

But market forces have limits even when the culture is supportive. Many problems are just too big to be left to rival profit-seeking companies. For traditional utilities, competition is impractical. For education and healthcare, profits are at best an incomplete standard of success. In some circumstances, as when innovations bring broad economic and social change, market forces may have a quite limited role to play.

Consider one of the nascent revolutions in the automotive business: electric cars. Concerns about pollution are driving the push for change. Legislators provide some of the most powerful incentives. Research institutes, often government-funded, lead many of the technological advances. Incumbent manufacturers strive to design cars that drivers will like while newcomers such as Tesla, Google and Apple try to find a position.

Market forces are helping, but if electric cars ever become a mass product, the main credit will go to other parts of the economy. They would never have had a chance without ever tighter clean-air legislation. And they will never get anywhere with big changes in energy infrastructure, not to mention regulated standardisation of technology and provisions to help shrink the huge oil refining and distribution industry.

Similarly, driverless cars are too revolutionary for striving private competitors to run the show. The whole society, working through lawmakers and regulators as well as many related industries, will have to develop most of the technology, establish safety standards and set the new rules of the road.

Such revolutions will almost certainly require more money than private investors and lenders will be willing to provide. The issues are too wide-ranging for market actors – investors, companies and customers – to direct. Rather, new and old companies will have to work with politicians, lawyers, academics and regulators.

Most of the key technology should be shared. Some of the best people should work to provide imaginative and flexible lawmaking and regulation. Even with the best efforts, some unfair and sub-optimal compromises are inevitable. However, negotiated unity is preferable to chaotic dislocation.

In truth, the car business, like most capital-intensive and socially significant industries, is already more of a mélange than a simple competitive market. The profit-seeking companies compete with each other, but they also work alongside numerous government and quasi-government regulators and institutes. They often work together in education, lobbying and research.

That makes sense. Textbook market forces cannot meet the complicated challenges of complex economies. It is a fact that investors, politicians and business school teachers need to recognise. Market forces and competition are helpful. Planning and cooperation are essential.

 

 

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