"Rip-off Britain" is one of those phrases that, from time to time, slips unexamined into the public mind. In an opinion poll conducted late in 1999, 93 per cent of respondents said they had been "over charged" for goods and services in Britain. 84 per cent of respondents blamed "company greed" for this. 75 per cent wanted government action to force prices down.(1)
The politicians agreed. "It is wholly unacceptable to this government that some consumer goods can still cost twice as much in Britain as in America and we propose tough action" Chancellor Gordon Brown announced in a speech given around the same time to provincial newspaper executives.(2)
The Government Investigates
True to its word, the Government launched a series of investigations into "anti-competitive" practices in a number markets. There were prices of soft drinks in public houses, where apparently orange juice was being sold at nine time the prices being charged in supermarkets.(3) There were cars, which apparently cost significantly more than in mainland Europe. Most famously, though, there were the practices of the leading food retailers. These are the "big five" - Tesco, Sainsbury, Asda , Sommerfield and Safeway—responsible for about three quarters of sales in a market worth £90 billion a year. They were accused of the following offences against the notion of perfect competition:
First, the profits earned by food retailers are too high—that is, they are higher than the levels supposedly needed to keep the retailers in the market. For example, the Tesco profit, announced in January 2001, was £1,065 billion—up considerably on the previous year.(4) This pushed Tesco shares higher on the stock exchange, where they had already risen by 52 per cent in the previous 12 months, compared with an average 29 per cent fall in shares in other non-cyclical service companies.(5) Therefore, Tesco must have been charging prices for its products higher than average costs. In short, consumers must have been "ripped off".
Second, they are persistently selling below cost. They do this by cutting the prices of everyday items such as bread and milk, to encourage people into their superstores. This is said to be "unfair competition" with smaller outlets.(6)
Third, they are selling at different prices in different regions. Economic theory states that if goods are produced and sold in perfectly competitive markets, and if there are no barriers to trade, such as transport costs, and if consumer taxes are much the same, then we should expect to pay much the same for them everywhere. If there are different prices charged within one country for the same products, it is taken as evidence of anti-competitive practices.
Fourth, they are earning their large profits by unfairly squeezing their suppliers. Their custom is to contract with farmers to buy the whole of their produce at a low price, leaving farmers with very low margins. These contracts are usually unwritten, and can be varied without warning. The Government investigators found 52 way in which the food retailers squeeze their suppliers—ranging from "requests" for retrospective discounts to assumptions the suppliers would provide corporate hospitality. Apparently, they also demand cash payments. One supplier claimed to the investigators to have received three demands for cash payments in recent months from one supermarket chain. "The third by telephone was for £100,000 and was claimed by the supermarket as a contribution towards profits.(7)
Ben Gill, President of the National Farmers' Union, said he had received complaints from farmers and growers who felt under threat from "the excessive or unreasonable demands of supermarket contracts".(8)
Even the Prime Minister joined the attack on the food retailers' treatment of their suppliers. Speaking to farmers in March 2001, he said:
We all want cheaper food in our shops but, on the other hand, the supermarkets have pretty much got an armlock on you people at the moment.... That's something we have got to sit down with them and work out.(9)
The Government Climbs Down
In the event, this investigation came to very little. When it reported back in October 2000, the Competition Commission announced that there was no evidence that shoppers were being overcharged. According to Stephen Byers, the Trade Secretary, "excessive prices are not being charged nor excessive profits earned".(10) The investigation had taken two years to complete, and had cost the tax payers £20 million—making this the most expensive commercial investigation ever.
In fact, prices charged by the food retailers have been falling - sometimes sharply—for several years. In 2000, overall food prices fell by 0.4 per cent.(11) These declines owe something to the falling Euro—much food is imported into Britain from Euroland, and so a lower Euro means lower prices. But there is also fierce competition throughout the food retail sector. Since the early 1990s, several low price German retailers have moved into the British market. In 2000, Wall Mart, the biggest food retailer in the world, bought Asda, and announced that it would compete all its British rivals into the ground.
Though the mainstream theory of the firm regards the food retail sector as an oligopoly, it is undeniably an unstable oligopoly, characterised by hectic building of new stores and deep competitive price cutting. The result is arguably some of the lowest food prices in the European Union. According to research conducted by Tesco—not an independent source, perhaps, but not one likely to be telling reckless lies—a typical basket of 131 grocery items is cheaper in Britain than in France, Germany, Italy, Belgium and Holland. These finding emerged after currency distortions were removed from the comparisons.(12)
As for suppliers, no one forces them to do business with the big food retailers. They can sell their output as and where they please. If they are queuing up to do business with the food retailers, that is because they evidently prefer prices but guaranteed sales to higher prices but uncertain sales elsewhere in the market. They are freely consenting adults. If they cannot be expected to make rational choices about how best to sell their output, they should perhaps consider other lines of work.
Sadly, the Government does not agree with this last point. One of the Competition Commission's positive recommendations was the creation of a binding code of conduct for dealings between the food retailers and their suppliers. However, this may require an Act of Parliament, and the legislative timetable is already crowded for several years to come. Perhaps nothing may be done.
In general, the food retailers provide excellent value for money. People frequently complain how the building of superstores is destroying small outlets and draining the life out of traditional shopping areas in town centres. But the food retailers are not doing this. That is the work of ordinary consumers. In an age when increasing number of married women are going out to work, consumers prefer the convenience of buying all their food a week at a time under one roof. The so called golden age of the small food retail outlet turns out to have involved high transaction costs in terms of time, and higher prices than people wanted to pay. If the superstores have risen to dominate the market, that is because freely consenting adults have decided that this is what they really want.
The Myth of "Rip-Off Britain"
Opening the debate beyond the narrow issue of the food retailers, we can see that the claims about a price structure distorted by abusive monopoly power are false.
By definition, in a perfectly competitive market, goods of the same kind will sell at the same price. Assuming no trade barriers between or within countries, the same transport and distribution costs, the same level of taxes, no branding, and perfect knowledge, instant coffee should sell at the same price in York as in New York. But it does not need an economics degree to know that the real world does not match this assumed world of perfect competition. Consider:
First, competing goods are never of identical quality. They are always differentiated in some way. This can be in the obvious sense of being differently sized or differently coloured. They can also be branded. These two facts will allow for large differences in price for goods that perform identical functions. People will pay more for goods that look attractive. They will pay more for goods that have a known and reputable brand name attached to them.
But goods can be differentiated in other, less obvious ways. To go back to the example of soft drinks in public houses, orange juice may be an undifferentiated product, but it can be part of a highly differentiated more complex product depending on where it is bought and for what reason. In a supermarket, it is bought for later consumption off the premises, and consumers will be reluctant to pay more than the cost of packaging and transporting the juice—and competition will force the price towards this level. In a public house, it is bought as part of an overall experience. There is the decor, the music, the opportunity for shared company, and so forth. Providing these things involves cost, which will be reflected in the price of the juice.
This will also help explain differences in price for the same clothes depending on where they are bought—in a discount warehouse or in a designer boutique. In the latter case, it is not simply clothes that are being bought, but service and surroundings that are included in the selling price of the clothes. Sometimes, these costs can be far greater than the cost of the clothes.
This is not an imperfection in the market. It is a reflection of different consumer tastes. As Hayek says,
[i]t would clearly not be an improvement to built all houses exactly alike in order to create a perfect market for houses, and the same is true of most other fields where differences between the individual products prevent competition from ever being perfect.(13)
Second, transport and distribution costs are always different. It costs more to bring cars to market in rural Wales than in the town where they are made. As with the clothing case given above, these additional costs may be a significant proportion of overall selling costs. And there will always be wide differences between these costs in different countries. In America, distribution costs are lower per mile than in England, but there are more miles to travel. In event, total costs are lower in America, but it could easily be otherwise.
Third, different regions have different factor endowments, and these will be reflected in selling costs. Land and unskilled labour are both more expensive in the south of England than in the north. This will affect the retail service component of products, meaning that there could easily be different prices for the "same" goods, depending where in the country they are bought.
Fourth, there is the matter of demand. Many products cost more in London than in other parts of the country because people are willing and able to pay more for them. Haircuts cost more in Kensington than in Cardiff because people in Kensington have more money to spend on looking after their hair.
Fifth, taxes are different in different countries. There is much discontent in Britain over the high price of petrol, which is causing public relations difficulties for the oil companies. However, more than three quarters of the price of a gallon of petrol is taken in taxes of various kinds, which helps make British petrol among the most expensive in the world. But there is no relationship between these prices and the profits of the oil companies. If tax is discounted from the price of petrol, it becomes about the cheapest in the European Union.
Sixth, it is the same with levels of regulation. This will be discussed in greater depth elsewhere, but it is worth pointing out that British enterprise is very highly regulated. According to Phil Evans of the Consumers Association, it is hard for new entrants into most retail sectors. Sites suitable for larger stores are almost impossible to find and require years of negotiation to navigate the planning system. According to Joanna Waterous of McKinsey, "regulation stops companies selling the same baby car seat in the UK as is on sale in the US or France. That means smaller production runs, costlier distribution—the economics are not good".(14)
Seventh, trading environments are seldom the same. Because of cheaper land, there are more and larger superstores outside the south east of England than inside. This means different scales of operation, and therefore different average costs. These differences of scale are particularly important for explaining price differential between countries. They apply especially to complaint mentioned above by Gordon Brown. Goods are cheaper in America for all the reasons given, but also because they tend to be sold from much larger premises, where economies of scale are possible that are denied to retailers in this country.
According to a 1999 study by the Organisation for Economic Cooperation and Development, Britain is actually rather a low price economy compared with France or Germany. The report notes that current price comparisons are influenced by sterling's appreciation (which makes overseas prices appear cheaper). It also analyses mark-up ratios in America and Britain in an attempt to find out whether Britain suffers a lack of competition, which might explain why prices in many sectors appear higher. Higher British mark-ups would suggest that retailers were overpricing. "But the ratios are very similar, conveying a rather different picture from the government's 'rip-off Britain' rhetoric"(15)
Joanna Waterous agrees. She says it is not clear that margins or returns on capital are higher in the UK once differences in accounting practices are stripped out. "Margins have been declining for five years, as have returns on capital" she adds.(16)
Closing Suspicions
The Government has largely given up now on its "rip-off Britain" campaigns. The reports have come in and have shown no real sign that companies are making vast profits due to some monopoly power. But it is worth asking why the campaigns were started.
There are two ready explanations. The campaigns were shamelessly populist. They let the politicians empathise with their electors in a very public way. Politicians will normally do anything to get themselves perceived as real human beings, rather than animated wax dummies. Complaining about the price of orange juice in public houses can seem a good way to change perceptions. Then—to repeat—there is the fact that none of the present Ministers has been committed to free markets longer than about ten years. They all used to be socialists. Though they have abandoned the more dramatic and obvious forms of socialism, it would be astonishing if no residue had survived of their old belief that profits can only arise from exploitation, either of workers or of consumers.
But there is a third possible explanation. No government—at least, none in the English-speaking world—is likely to last very long if it puts up income taxes. The British Government, however, has some ambitious spending plans for the next few years. These need to be financed from somewhere. There are limits to the number of what the Conservative opposition calls "stealth taxes". While excise duties and other consumption taxes used to be an almost invisible way of extracting money from the people, the great fuel protests of September 2000 have shown that these have their limits.
And so an attack on "excessive" profits might have seemed a useful prelude to raising taxes. Let it be granted that companies were making large profits by exploiting some degree of monopoly power. Let the Government then intervene in the manners sanctioned by the welfare economists to increase competition and thereby drive down prices. Then let indirect taxes be raised by almost the same amount as the fall in prices. The result is higher tax revenue without pubic discontent.
Sadly for the Government—if this was part of the intention—the monopolistic practices with which large companies had been charged turned out to be either illusory or much less important than claimed.
1. John Willman, "The price isn't right", The Financial Times, London, 4th October 1999.
2. Source: ibid.
3. News article, "Pub drinkers 'overcharged', The Financial Times, London, 2nd October 1999.
4. Leslie Kraft Burke, "Rivals left standing as sales push Tesco ahead", The Financial Times, London, 16th January 2001.
5. Ibid.
6. Benedict Brogan, "The weekly shop is not too costly, Byers told", The Daily Telegraph, London, 11th October 2000.
7. Jean Eaglesham and Peggy Hollinger, "Watchdog's bite worse than bark: supermarkets inquiry", The Financial Times, London, 16th October 2000.
8. Benedict Brogan and Alistair Osborne, "The weekly shop is not too costly, Byers told", The Daily Telegraph, London, 11th October 2000.
9. George Jones, "Blair's attack unfair, say supermarkets", The Daily Telegraph, London, 3rd March 2001.
10. Benedict Brogan and Alistair Osborne, "The weekly shop is not too costly, Byers told", The Daily Telegraph, London, 11th October 2000.
11. Leslie Kraft Burke, "Rivals left standing as sales push Tesco ahead", The Financial Times, London, 16th January 2001.
12. John Willman, "The price isn't right", The Financial Times, London, 4th October 1999.
13. F.A. Hayek, "The Use of Knowledge in Society" ( Individualism and Economic Order), p.88.
14. Both quoted from John Willman, "The price isn't right", The Financial Times, London, 4th October 1999.
15. Kevin brown, "Finding a measure for the unmeasurable", The Financial Times, London, 29th December 1999.
16. Quoted from John Willman, "The price isn't right", The Financial Times, London, 4th October 1999.