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Issue 18/20 January 2010

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Today’s Issue Includes:


1) New ombudsman to monitor supermarkets:
A Case Study by Nigel Tree

nigelcropforezineIntroduction
Following on from a recommendation by the Competition Commission in 2008, the government is only now announcing plans to introduce an ombudsman, who will enforce a new code of practice between supermarkets and their suppliers from 4th February.

The problem at the moment is that no-one knows who the ombudsman will be, what the code of practice will contain and what powers of enforcement will be put in place. Still, it is another headline grabbing announcement.

The rationale behind the move was put forward by Kevin Brennan, the minister for consumer affairs, who said: “..the power that large grocery retailers remain able to wield over their suppliers can still create pressures on small producers, especially in these difficult economic times, which ultimately may impact on consumers.”

Oligopoly isn’t a problem…
The concerns in the past have been that there is an oligopolistic group of four main retailers, Tesco, Asda, Sainsbury’s and Morrisons, which together control over three-quarters of the total market. Repeated investigations by the regulatory bodies have failed to find that this dominant position is abused. In fact, yesterday, the British Retail Consortium claimed that: “OFT Chief Executive John Fingleton has said supermarkets are pro-consumer, bringing lower prices, innovation and new services and an ombudsman is not necessary.”

….but oligopsony is.
However, there are still concerns over the oligopsonistic power of the supermarkets. Oligopsony is where there are few buyers but potentially many sellers. This can be contrasted with oligopoly, where there are few sellers and many buyers. Because food producers in the UK virtually have to sell to the four main supermarket companies to survive, it is argued that the supermarkets hold unreasonable power over suppliers and can force them to accept prices and conditions which are not in their long-term interest.

According to Andrew George MP, chairman of the Grocery Market Action Group, and quoted on the National Farmers’ Union website yesterday: “Larger retailers have grown to become very powerful and can dictate market conditions. Their practices have transformed over 20 years from their effective and successful use of their power to an unacceptable abuse of their market muscle.” He also said concerning the introduction of an ombudsman: “…there will be quiet jubilation amongst British farmers and the developing world.”

The National Farmers’ Union has been particularly concerned about the plight of the UK’s dairy farmers. They claim that of the £1.70 which a supermarket customer may pay for two litres of milk, less than 50p will go to the farmers.

Also, the charity War on Want argues that: “Many South Africans earn well below a living wage on farms supplying fruit and wine to UK supermarkets.” They have also said that “Kenyan and Columbian workers face poverty pay supplying flowers to British supermarkets.”

However, these latter points ignore the fact that supermarket buyers do not buy direct from workers but from the companies that hire these workers. They presumably negotiate a price which is acceptable to the companies selling wine, fruit and flowers. Should they approach sellers by saying: “Excuse us, but we don’t think that you are charging us enough.” And even if they did pay more, there is no guarantee that extra money would go through to the workers rather than into the profits of the third world suppliers. Perhaps the onus is on governments abroad to impose minimum wages for workers. But even if that were the case, theory would suggest that a minimum wage above equilibrium would result in a fall in employment.

Who are the main suppliers?
It could be argued that UK supermarket companies are on the whole negotiating with companies that are as large as themselves, for example the Kraft Foods and Proctor and Gambles of this world. This is the line taken by the British Retail Consortium. On 13th January their Director General, Stephen Robertson, commented on the new ombudsman saying: “This would tip the balance of negotiating power in favour of multi-national food manufacturers allowing them to drive up the prices customers pay. This is not about farmers, very few deal directly with supermarkets … The UK grocery market is worth £130bn a year. If threats of involving an ombudsman allow big food companies to squeeze even 0.1% more out of supermarkets, that’s £130 million extra on customers’ bills.”

Presumably the UK government is not too much concerned about the ability of huge US multinationals to fight their corner against the likes of Tesco and Asda. They are more concerned about the ‘little guys’. But, it could be argued, that the dream of most small producers is to be able to sell to the big supermarket companies. However, Kevin Brennan in a written statement to Parliament said: “The power that large grocery retailers remain able to wield over their suppliers can still create pressure on small producers.”

Should small producers be guaranteed a living? Is it just emotive to note how many small farmers are going out of business? Should we not be looking for efficiencies from large-scale production in the agricultural sector? I haven’t yet heard anyone yet saying that small publishers should be protected, or individual care homes or Chinese restaurants.

What can we expect from the new legislation?
At least the government has decided that the new system will not bear a burden on the taxpayer. The Department for Business, Innovation & Skills has said that the new ombudsman system would cost £3.7m to set up and an additional £1.3m a year to run. It also proposed that this money should be found by the supermarkets and that in effect they should pay to police themselves. Let’s hope they do not drive down suppliers prices to pay for it.

Will this legislation have a positive effect? At this point it is too early to say as we do not even know what sort of powers of compulsion, if any, the ombudsman will have or how it will be determined whether supermarkets are paying a “fair” price for their products. If they are somehow forced to pay higher prices then these will doubtless by passed on to consumers.

Questions for discussion

  1. An oligopoly market can be one where there is fierce competition and low prices. Does it follow that an oligopsonistic market is necessarily ‘bad’? Are there any advantages to suppliers of being in this sort of market?
  2. To what degree should UK supermarket companies be responsible for wages in developing countries where they source their products? What other forms of worker protection might be appropriate?
  3. If suppliers get paid more at the expense of supermarkets through government intervention, does this not just mean that consumers will end up paying higher prices? And would this then be a case of government failure?

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Available at the beginning of February

The UK Economy 1999-2009 by Ian Black

New 120 page book covering the last ten
momentous years in the life of the UK Economy.



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2) What is happening to UK manufacturing by Ian Black, St.Albans School

Ian Black’s new edition of The UK Economy 1999-2009 is about to be published in the next couple of weeks. Below is an excerpt from the book on the decline of manufacturing. In the book each area covered is designated as covering the skills of either Knowledge, Application, Analysis or Evaluation.


Knowledge and Application: The decline of manufacturing
Manufacturing today only accounts for 12.4% of UK output. The service sector, in contrast, now accounts for 76% of UK output and over 80% of UK employment. The UK is now a ‘post industrial’ or information economy.

In the last thirty years, the UK has suffered a decline in the share of output and employment accounted for by the manufacturing sector (Table 1). This phenomenon is known as deindustrialisation. However, labour productivity in UK manufacturing has improved considerably. This has been due to higher investment in fixed capital equipment, IT and the skills of the workforce. Nonetheless, the UK has surrendered its comparative advantage in many manufacturing sectors, though it retains a comparative advantage in pharmaceuticals.

Table 1: Deindustrialisation in the UK

deindustrialisationintheuk2_400

Figure 1 illustrates the contrasting growth performance of mining, quarrying and manufacturing compared to the other sectors. In fact, manufacturing output declined in 2001-3, 2005 and 2008-2009Q2. Two reasons cited for the recession in manufacturing in 2001-3 were:

  • The slowdown in global economic growth
  • The strength of the pound sterling that hampered export competitiveness


Both the machine tools industry and clothing and textiles sector were hit particularly hard because of the strength of the pound in the late 1990s. Other industries hit during the 2001-3 recession include:

  • Aerospace manufacturing
  • Computer manufacturing
  • Office equipment
  • Electrical engineering
  • Telecommunications engineering

Figure 1: Growth of UK industries by sector, 1999-2008

growthofukindustriesbysector2


In 2005, transport equipment and electrical goods were two other industries to suffer. In 2006, however, manufacturing growth rebounded. UK manufacturing is heavily dependant upon exports, and a growing world economy in 2006, as well as an unexpected fall in the oil price in the second half of the year, helped in the recovery.

Manufacturing, like all other sectors, has experienced a collapse in output during the 2008-9 recession, although it has been hit harder than most service sector industries in terms of loss of output and job losses. Anecdotal evidence suggests that car manufacturing, as well as industries that supply the car industry, engineering and textiles have suffered particularly. The construction industry also experienced a particularly sharp fall in output in 2008-9, having shown strong growth over the previous ten years as is evident from Figure 1.

Analysis: Why has deindustrialisation occurred?
In a 'mature' economy such as the UK, consumer demand inevitably switches away from manufactures towards services: services have a higher income elasticity of demand than manufactures.

Foreign competition from regions such as East Asia and Latin America means that the UK no longer has a comparative advantage in manufactures. As much of UK manufactured output is traded then manufactured output growth will be slow.

Given that a similar process has occurred in other developed market economies, slow manufacturing growth does not initially seem a cause for concern. It should also be noted from Figure 2 that until the 2008-9 recession the UK manufacturing sector was not contracting. It is the share of output accounted for by manufacturing that has been falling over the long term. Note the continuous rise in the output of the service sector over the ten year period 1998-2008.

Figure 2: Index of output of selected industries, 2005=100

index_of_output_of_selected_industries

Evaluation: Does manufacturing matter?
Nonetheless, some commentators have claimed that manufacturing is more important than its 12.4% of GDP suggests and deserves special treatment. The reasons are as follows:

  • There is greater scope for productivity improvements, innovation and technological improvements in manufacturing than in the service sector. This is because the service sector is labour intensive and there is little scope for capital-labour substitution, making technological change difficult to implement.
  • Most research and development (R&D) in the private sector is conducted in manufacturing: it is responsible for around 75% of UK R&D. R&D is becoming a more significant determinant of growth in the industrialised economies. A healthy manufacturing sector will mean innovation, productivity improvements and therefore increased long term economic growth. Given that the UK still has a productivity gap with its major competitors, this argument seems difficult to ignore.
  • Manufacturing accounts for 60% of UK exports of goods and services. One of the reasons for the UK's chronic or structural current account deficit is the decline in the value of manufactured exports relative to imports. However, the deficit in goods can be made up by other factors such as investment income and services. This is true up to a point: however, the UK is also likely to remain a net importer of primary products as well as manufactures. Taken together, the deficit in these areas has tended to outweigh the surplus in services and investment income.
  • Manufacturing generates millions of jobs both directly and indirectly through the supply chain. In fact, manufacturing has more forward and backward linkages than any other sector of the economy.

On the other hand, the assertion that the UK economy simply doesn’t make anything any more does not stand up to scrutiny. In absolute terms, the volume of UK manufacturing output in 2007 was at a record high, twice the 1955 figure. The UK has lost its comparative advantage in traditional manufactures such as textiles and shipbuilding, but has since ‘traded up’ to higher value added manufactures. The UK remains a world leader in certain hi-tech industries: for example, eight out of the twelve Formula 1 teams scheduled to be on the grid for the start of the 2010 season base their teams in the UK! There is also nothing wrong with the UK importing tangible goods in exchange for exporting non tangibles, such as financial services exports. It should be noted, however, that our trade deficit in goods is larger than our trade surplus in services.

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