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A fog descending on Australian agricultural markets

Mick Keogh, Australian Farm Insitute, February 10, 2012

In this analysis first published in the Australian Farm Institute’s February 2012 quarterly newsletter, Mick Keogh explains that a loss of market transparency has been an unintended consequence of industry deregulation in Australian, as market power has gradually being concentrated into the hands of a few major players in each industry.

Mandatory reporting in other countries has been used to improve market transparency so that all participants have access to similar price and volume information. On the 22nd of July, 2011, the Australian Competition and Consumer Commission (ACCC) handed down its findings arising from an inquiry into milk pricing in Australia.

The inquiry was initiated when a major supermarket chain commenced heavy discounting of its house brand milk, selling it for $1 per litre, and this was quickly followed by several other supermarket chains.

The inquiry was held to determine whether the supermarket chain had breached Australian competition laws, and the issue was also the subject of a Parliamentary inquiry.

The ACCC inquiry addressed two issues – firstly whether the supermarket chain was engaging in milk price discounting mainly for the purposes of reducing competition.

Secondly, whether this was a case of ‘predatory pricing’ (where a business that has substantial  market power sells products for a sustained period at a price below the cost of supply) again with the intention of lessening competition.

The main conclusion of the ACCC inquiry was that: "The major impact of the reduction in milk prices since January seems to have been a reduction in the supermarkets’ profit margins on house brand milk.
These price reductions have benefited consumers who purchase house brand milk".

As a result the ACCC concluded that the supermarket chain’s main objective was to increase its market share, rather than to reduce competition, and there was no breach of Australian competition laws.

What was interesting about the finding was the careful use of the word ‘seems’ in the ACCC  statement announcing the findings of the inquiry.

The use of the word appeared to indicate that there was some uncertainty about the finding, and suggested that the ACCC may have made the findings on the basis of the information that it had available at the time, which may have had some limitations.

A Freedom of Information (FOI) request that was subsequently lodged with the ACCC seeking access to the milk price data that was used to reach this conclusion elicited the response that virtually all the data the ACCC relied on was confidential, and could not be disclosed to third parties.

Some very limited information that was made available following the FOI request was heavily  redacted, and largely irrelevant to the issue because it came from dairy processors which did not supply supermarket chains.

While the response to the FOI request was not unexpected, it highlighted a wider issue in relation to agricultural markets in Australia, which is the growing lack of market transparency that is making it more and more difficult for farmers to make informed decisions about the prices they receive for farm produce, and ultimately their production decisions.

The issue of market transparency has long been contentious in the horticulture sub-sector (where   despite decades of argument it is still no clearer whether agents operating in fresh produce markets are commission agents selling on behalf of growers or traders who take a principle position in the produce they handle). 

It is now also emerging in the dairy industry post-deregulation, and also in the grains industries where growers often complain that grain pricing and grain pool rules are becoming feature more opaque and difficult to access.

Reliable reporting of grain traders’ stock positions has all but disappeared.

The issue of market transparency also emerges on occasions in the livestock industries as open-cry auction systems decline in importance and direct supply marketing arrangements increase; although industry market reporting systems for cattle, sheep and wool provide an important source of  independent market information for farmers, and assist with market transparency in relation to these commodities.

It is arguable that in all the transformative changes that have occurred in Australian agriculture over the last three decades, the one key issue that has been overlooked is the importance of market transparency in order to bring about efficiently functioning markets.

Policy-makers and industry participants alike were often very keen to remove any statutory  interventions in markets in order to ensure that farmers became more responsive to the needs of the market, and in doing so often removed market reporting activities without giving due  recognition to their importance.

 

Efficient markets

Neo-classical or conventional economic theory has its foundations in the writings of Adam Smith and others, and contends that perfectly competitive markets (the ‘invisible hand’), free of government intervention, provide the best opportunity for society to maximise the economic benefits able to be  generated from available resources.
The rapid pace of economic development in nations with relatively limited government market intervention compared with the sluggish growth of many nations with government-controlled markets is often cited as strong evidence in support of this theory.

There are a number of conditions considered necessary for perfectly competitive or efficient markets.

These include:

1. buyers and sellers are too numerous and too small to have any degree of individual control over prices

2. all buyers and sellers seek to maximise their profit (income)

3. buyers and sellers can freely enter or leave the market

4. all buyers and sellers have access to the same information regarding availability, prices, and  quality of goods being traded

5. all goods of a particular nature in a specific market are homogeneous, hence substitutable for one another.

Many critics of neo-classical economic theory have pointed out that these conditions are not ever found in ‘real world’ markets, and that therefore perfectly competitive markets do not exist. Nobel prize-winning economist Joseph Stiglitz, for example, argued that there is no such thing as the ‘invisible hand’, especially because of imperfect market information (where one party to a transaction holds a lot more information than the other) and his work and that of other economists has led to a much greater focus on the importance of information and transaction costs (all the costs associated with contracts and arrangements between market participants) as factors distorting markets.

When markets divert from these ideal conditions, it is argued that society as a whole can benefit if governments intervene and attempt to correct the problem.

Neo-classical economists argue that such interventions should be minimised, whereas Stiglitz argued that markets can almost always be improved by some government intervention.

Common justifications for government intervention include addressing unfair competition, correcting unequal access to information, reducing negative spillover effects (such as pollution) or encouraging positive spill-over effects (such as the revegetation of land to promote biodiversity).

There are a number of different forms of government intervention that have been attempted in the past.

These range from ‘strong’ – such as compulsory acquisition, regulation of prices and government stockholding, through to ‘weak’ such as licensing participants, the implementation of industry standards and codes, and requirements to report stockholdings and prices.

In the past, national governments tended to adopt quite strong forms of market intervention, and many of these involved agricultural markets.

Over recent decades many of these have been abandoned as markets have been deregulated and international trade has rapidly expanded.

 

Australian agricultural  market interventions

Many of the government interventions in Australian agricultural markets prior to the 1990s aimed to address one or more perceived diversions from efficient market conditions.

The wool reserve price scheme, for example, was established in 1974 to guarantee woolgrower returns and to prevent overseas buyers taking unfair advantage of the weak bargaining power of woolgrowers.

The wheat single marketing desk was established in the late 1930s to maximise returns to growers, to manage wheat exports and to regulate wheat markets following the extreme fluctuations associated with the global economic turmoil of the 1930s.

Dairy markets were regulated from 1924 to control dairy exports and to manage the supply and safety of fresh milk. Horticultural markets were regulated, mainly by state governments, to improve grower returns and to prevent unfair competition in fresh produce markets involving perishable goods.

By the early 1990s, most of the government interventions in Australian agricultural markets were  judged to be imposing more costs on the economy than benefits, and were therefore dismantled.

Despite the heated debates at the time, Australian farmers have now largely accepted the changes and become accustomed to operating in unregulated or ‘free’ markets.

Few would argue, however, that the agricultural markets that have evolved since that time could be considered perfectly competitive markets.

Generally speaking, markets have become more concentrated with just one or two participants dominant (for example retail supermarkets, meat processors, dairy processors and fertiliser suppliers) and able to influence prices (as the ‘milk wars’ have clearly demonstrated).

In other cases (such as grain markets) restricted access to transport and shipping infrastructure prevents new players from competing, and access to reliable market information about stocks and prices has become more difficult.

Contract supply chain arrangements have also been developed between farmers and major buyers which restrict the availability of market information, and can constrain the ability of farmers to supply alternative markets.

While recognising these market problems, the challenge for governments is to decide the extent and form of intervention that might be appropriate, but that avoids the distortionary effects of some of the strong forms of government intervention that were adopted in the past.

Approaches adopted by governments internationally provide some examples worthy of consideration.

International approaches

Agricultural markets in nations such as the United States (US) have been subject to considerable government scrutiny at different times, although the US has generally not adopted some of the stronger forms of market intervention such as statutory marketing  arrangements.

Instead, regulators in the US have opted for a combination of relatively strong ‘anti-trust’ laws, supplemented with measures that enforce market transparency by making the reporting of prices and volumes mandatory.

The United States Department of Agriculture (USDA) was first given the role of reporting agricultural markets in 1914, in response to concerns about the fairness and efficiency of markets, and in order to administer government food production incentives during World War 1 (Ward 2006).

The market reporting system was further expanded during and after World War 2, and coordinated between the US Federal Government and the states, with the main focus being on livestock markets.

As markets became more concentrated and marketing systems became more diverse, pressure grew to make reporting mandatory for all types of livestock markets, rather than just relying on reports from major livestock selling centres. The Livestock Mandatory Reporting Act was enacted in 1999, and has since been re-enacted, most recently in 2010. It requires all participants in livestock markets to report purchase volumes and prices, including meat processors purchasing livestock directly from farmers or feedlots.

The Agricultural Marketing Service (AMS) of the USDA compiles and publishes market reports based on this information. The AMS also publishes market reports for a wide range of different agricultural commodities, including fruit and vegetables, grain, fodder, dairy products, poultry, eggs, cotton and tobacco.

It also has wider responsibilities associated with grading standards, and laws such as the Perishable Agricultural Commodity Act, which regulates contractual arrangements in fruit and vegetable markets.

A focus on market transparency is also apparent in agricultural commodity markets operating in Europe.

The commodity price reporting systems of European nations have multiple purposes, as some are mandated under European Union regulations (for example Commission Regulation 562/2005 concerning mandatory milk price reporting) to enable EU farm payment schemes to operate, while others are implemented for the purposes of maintaining market transparency, monitoring industry margins and enabling governments to check for potential breaches of fair trading or competition laws (such as the French Rural and Fishery Bill of 2008).

The market information arising from these programs is also widely published, in order to ensure farmers have access to relevant and timely market information. France recently established an agency to monitor food prices and food industry margins, using supply chain price data and economic modelling to monitor prices and margins along food supply chains.

What is evident from these examples is that rather than attempting to regulate markets, the main focus of these measures is on improving market transparency, so that all participants have access to similar price and volume information.

This, in turn, helps to ensure that farmers and processors make efficient decisions about how available resources should be utilised, creating benefits right through the marketing chain and for the wider community.

In addition, greater market transparency acts as a deterrent to anti-competitive behaviour; because it means that there is a greater chance such behaviour will be detected.

 

Agricultural market transparency in Australia

As noted earlier, Australian governments have progressively deregulated agricultural markets over recent decades.

While many of the resulting changes have been of benefit, an unintended consequence has been that markets are becoming much less transparent, and there is therefore an increased risk that these will become less efficient.

There is also an increased risk that anti-competitive market behaviour will go undetected, because even though authorities such as the ACCC have legislative powers, a lack of transparent market information makes such behaviour almost impossible to identify or prosecute.

This problem was, perhaps unwittingly, highlighted in some recent comments attributed to the Chairman of the ACCC, in response to media stories about abuse of market power by major Australian retailers (Australian Financial Review 2011).

ACCC Chairman Rod Sims was quoted as asking those affected by misuse of market power to provide evidence to the ACCC of such behaviour, so the Commission could take action.
‘We need evidence and so we need people to come forward’, was the quote attributed to him.

The reality, of course, is that in markets dominated by just one or two major participants, there is such a lack of transparent market information that it is almost impossible for a small-scale supplier to  provide ‘evidence’ and in any event to do so would almost certainly mean that business was no longer a supplier to the particular retailer.

The call by the ACCC is equivalent to the police saying they will no longer patrol or investigate  criminal activity, and victims will have to find their own evidence if they wish to prosecute perpetrators!

Interestingly, Division 5 of the Australian Competition and Consumer Act 2010 (the legislation under which the ACCC operates) contains a series of clauses that empowers the ACCC to monitor prices in specified markets, but only at the direction of the Minister.

Perhaps rather than trying to encourage aggrieved persons to come forward with impossible-to-obtain information, the ACCC should be highlighting that the relevant Minister has the power available to improve market transparency, and in doing so to ensure Australian agricultural markets remain fair and efficient.

A related issue is the quality of available statistics about the feature agriculture sector in Australia, and the extent to which they might assist in informing these issues.

This will be the subject of a Research Report to be released by the Australian Farm Institute later in 2012.

This article reprinted with permission from the Australian Farm Institute

 

References

Australian Financial Review (2011), Bring me evidence of market abuse, says regulator, 5–6 November 2011.

Australian Competition and Consumer Commission (ACCC) (2007), Examination of the prices paid to farmers for livestock and the prices paid by Australian consumers for red meat, Commonwealth of Australia, Canberra.

Australian Competition and Consumer Commission (ACCC) (2011), Media release: Coles discounting of house brand milk is not predatory pricing, accessible at: http://www.accc.gov.au/content/index.phtml/itemId/998776/fromItemId/142

Ward, C E (2006), An Assessment of the Livestock Mandatory Reporting Act, 2006 Conference, 17–18 April 2006, St. Louis, Missouri 18998,NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.

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