Airlines and competition

I’ve been thinking about the fact that AirNZ is going to shut down Freedom Air in March 2008. With Freedom Air, Air NZ was able to serve the budget end of the market and the higher quality end by selling a differentiated product. However, the company could have simply offered different services in different compartments of the plane, it seems a touch over the top to create a whole separate brand just to get the advantage of price discrimination (at least in this case).

The true purpose of Freedom air was to prevent competition. By paying a whole lot of money to run a cut price airline, Air NZ was able to make it uneconomical for other potential entrants from coming into the market, as their marginal cost was greater than the price they could set when competing with Freedom. The investment in Freedom air acted as a form of commitment. As the investment in capital, goodwill etc for Freedom air was costly to reverse, Air NZ could credibly commit to fighting a new competitor on the Trans-Tasman route through the low prices Freedom charged, rather than just allowing them entry.

However, Air NZ has dropped Freedom right when Virgin was getting in on the act. I expect this is because the costly commitment to fight the new competitor was not sufficient to prevent the new competitor entering. As a result, Air NZ has decided to dump Freedom Air and just accept that there is a new competitor. I guess this is fair enough, as Virgin has some very deep pockets, and if Air NZ decided to fight them they may well be on the losing end. As a result, Freedom Air was a useful mechanism to reduce small scale competition in the market place, but it was not effective at preventing the arrival of one of the big boys.

In the future, I’m sure the case of Freedom Air will be a useful case study in how an incumbent can use costly commitment to prevent the entry of a new competitor. How do you think the commitment game functions in this case?

Fortnight in numbers

This time instead of being lazy I’ve actually been a bit busy, so here are some numbers from the last fortnight.

  1. Net annual arrivals fell to 8,730 in August
  2. Tourist arrivals rose 5.8%pa in August
  3. CA deficit came in at 8.2% of GDP in June
  4. Electronic sales rose 9.2%pa in August
  5. Core retail sales rose 5.0%pa in July
  6. House sales fell 9.8% (SA) between July and August
  7. TOT rose 0.6%
  8. Manufacturing output rose 3.2% (seasonally adjusted) over the June quarter.
  9. RBNZ didn’t change the OCR
  10. The exchange rate went between 0.686US and 0.746US busy times.

Where have all the socialists gone?

Over at Cato Unbound the health care debate rages on. David Cutler and Dana Goldman reply to Robin Hanson’s original article by almost agreeing with him. They both begin by acknowledging that much of our current health care spending is wasted. The gist of their criticism is that when you reduce health care consumption then you reduce necessary as well as ‘wasted’ health care. Consequently they call for increases in the effectiveness of spending rather than cuts to it. Note that Hanson never claims that the spending that does happen shouldn’t be controlled by doctors to ensure that necessary procedures still get performed.

Moreover, the criticism really seems to be an attempt to avoid the problem by simply wishing it away. Nobody denies that it would be nice if no health spending were wasted and it were all highly effective for treatment purposes: the fact is that it’s not and it probably never has been. As Hanson asks in his reply, “why must this distant possibility [of better health care] stop us from publicizing and acting now on our consensus that we expect little net health harm from crude cuts?”

Ezra Klein claims that some of the spending might be justified in order to raise peoples’ quality of life showing that we care. This might be a valid point, but I question whether that money couldn’t have a greater impact on peoples’ quality of life if it were spent elsewhere in the government’s budget. I have never been one to call for slashing social spending indiscriminately, but I’m surprised by how weak the replies to Hanson’s rather radical essay have been. The overwhelming response seems to be a knee-jerk rejection of such extreme spending cuts without a real refutation of the reasoning behind them.

Carbon taxes again…

It looks like Matt’s not the only brilliant economist campaigning for Pigovian taxation of carbon emissions. Now Greg Mankiw’s weighed in on the side of taxation. To those who claim a carbon tax is regressive because poor people are forced to live in the suburbs and drive more than the wealthy, Mankiw says

Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged.

In addition, the Economist points out that

…it’s possible that a carbon tax might sharply reduce carbon output without any fall in oil consumption, so long as consumers of other fuels affected by the tax reduce their use of such pollutants and their consequent emissions,

although this seems like a bit of a long shot.
In NZ, the government has preferred a cap-and-trade system to carbon taxes. Mankiw mentions that this is equivalent to a carbon tax only if the permits are auctioned off. If they are allocated for free based on previous emissions, as I believe the case will be in NZ (please correct me here if I’m completely mistaken), then “…the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers.” In other words, a cap-and-trade with grandfathered permits IS regressive and it’s expensive to redress the burden on the poor.

Fed cuts rates to 4.75%

I don’t have time to say much, but I will say that the Fed’s decision to cut rates 50 basis points was silly. They are pretty much telling the market that they will bail them out when the shit hits the fan from taking on overly risky investments. Although this decision may forestall a recession in the US, how many future recessions will be the result of the relatively new Fed governor Ben Bernanke showing that he will follow the whim of the asset market.

People are comparing this situation to 2000/2001 when Alan Greenspan cut rate significantly to stop a recession. If this was even true it would be an indictment of today’s decision, as in some ways the ease with which rates were cut in 2000/2001 lead to the asset bubble we are now facing.

However, todays decision is even worse than the 2000/2001 decision, as inflationary pressures are HIGHLY elevated. A good central bank should first and foremost control inflationary pressures. However, it seems that many central banks are starting to forget their primary goal.

Slavery and growth

Many writers have noted that colonisation contribute to the sad state of many African economies today. Now Nathan Nunn claims that the slave trade may also have had a long-term impact on economies. The author

…find[s] a robust negative relationship between the number of slaves exported from a country and current economic performance. To better understand if the relationship is causal, I examine the historical evidence on selection into the slave trades, and use instrumental variables.

This analysis indicates that “…it was actually the most developed areas of Africa that tended to select into the slave trades”, which points to a causal relationship running from slavery to poor economiic performance. The author suggests that the reason might be that “…procurement of slaves through internal warfare, raiding, and kidnapping resulted in subsequent state collapse and ethnic fractionalization.”

Yet another reason why the West is morally required to help African nations out of their current strife?