Canadians are accustomed to paying higher prices than our southern neighbours for a wide range of consumer goods: from books, to dairy products, to cars. The Canadian government recently introduced the price transparency act, a piece of legislation that would empower the Commissioner of Competition to investigate cases of alleged price discrimination against Canadians.[1] While the politicians backing this legislation acknowledge that differences in costs—caused by tariffs, transportation costs, labour costs, etc.—factor into price differences between Canada and the United States, they hold that some price differences are simply the result of firms “gouging” Canadians.
There is so much wrong with this legislation, it’s hard to know where to begin my critique. First, the whole premise of the legislation is founded on shaky economics. How, precisely, do firms gain the power to gouge consumers? Too often in mainstream industrial organization, the body of theory that motivates and informs antitrust authorities, industries are treated as if the number and composition of firms somehow fell from the sky. The complaint about price gouging amounts to the contention that too few firms fell out of the sky to sell particular goods to Canadian consumers, so the few that did fall are able to charge high prices. The whole argument unravels when we ask how industry composition is determined on the free market.
Ultimately, the number and size of firms in every industry is determined by entrepreneurs. Entrepreneurs decide which companies will be started, which will be shuttered, which will expand, and which will contract. They decide what will be produced, in what quantities, and according to what processes. Most importantly, they make all these decisions while facing uncertainty about the future state of prices. No entrepreneur is fully informed about the state of the world, but each entrepreneur may have some special insight or knowledge to help shape his decisions. By acting on this knowledge and insight in pursuit of profit, the entrepreneur incorporates his knowledge into the allocation of scarce resources. Entrepreneurs who forecast wisely, who produce where inputs are relatively cheap and outputs are relatively dear, earn profits. Entrepreneurs who forecast poorly, who produce cheap outputs with dear inputs, earn losses.
If we were to take a snapshot of this process at any instant in time, there would be plenty of firms earning profits and plenty earning losses. For a mainstream economist with a static conception of markets and competition, it would be tempting to point to the profitable firms as sources of inefficiency. After all, isn’t the ability to charge prices above marginal costs a de facto sign of “market power?” This static concept of competition gets things exactly backwards. If the bicycle industry is particularly profitable, it’s not the companies in that industry that cause inefficiency by their high prices; it’s every entrepreneur who could have entered bicycle production but directed his funds to other, less profitable, pursuits. The entrepreneurial profits earned in producing bicycles, or any other goods, are the reward for correctly anticipating prices and thus directing resources to their highest uses.
The price transparency act aims to seek out firms that sell profitably in Canadian markets and shame them into charging lower prices for their outputs. I’ve seen complaints that, since the legislation doesn’t grant the Competition Bureau the power to set prices, the investigations will create costs for the government and for compliant firms without having any real impact on prices. Actually, that would be the best possible outcome. The legislation would be far more disastrous if it succeeded in its goal of putting downward pressure on prices. To do so would remove the incentive for entrepreneurs to efficiently employ their knowledge and insight in allocating resources. While bailouts famously socialize losses while privatizing gains, antitrust actions to reduce “gouging” effectively socialize gains while privatizing losses. We all know how privatized gains and socialized losses led investors to take excessive risks in the lead up to the financial crisis. If the antitrust authority steps in to force profitable firms to reduce prices, effectively socializing gains, then entrepreneurs will be excessively averse to risk taking. Entrepreneurs will not seek out opportunities for high profit if they anticipate that government officials will order them to reduce their prices if they succeed.
High profits are what motivate entrepreneurs to zealously pursue opportunities. Whether they achieve those profits or not, in pursuing them they bring their best knowledge and insight to bear on the problem of allocating scarce resources. High profits motivate entrepreneurs the same way a carrot can motivate a donkey. Mainstream economists are too worried about losing the occasional carrot to realize that taking away the carrot would seriously impair the donkey’s motivation to walk. Taking away the carrot would save a carrot, but it would forfeit something far more valuable. Similarly, while pushing down prices that far exceed marginal costs could reduce the deadweight loss in a particular time, place, and industry, doing so would hamper the entire entrepreneurial process.
The allegation that there are some firms that can consistently charge prices well above costs amounts to the claim that there are huge, persistent profit opportunities that private entrepreneurs are somehow failing to seize. If the government is granting these firms monopoly privileges, the solution is not more legislation but the repeal of those privileges. It is implausible that any such opportunities would persist in a free market. If the government employees at the Competition Bureau actually succeed in finding such marvelous untapped opportunities, they should immediately quit their government jobs and start working to arbitrage away those opportunities. They would earn millions. And, in the process of enriching themselves, they would also succeed in closing the price gap that motivated this entire legislative project.
[1] “Canada-U.S. price gap complaints could soon trigger investigations” CBC News. Dec 9, 2014.
Tags: Canada, legislation, Price Transparency Act, prices
