Planning & The Rule of Law

A government should ultimately be bound by rules that are fixed and announced before it takes up any activity, this allows an individual to plan how they will go about their affairs, or in a more macro sense how firms should behave as they understand the manner in which government may use coercive power. Of course this system is not perfect in that the creators and administrators of these laws are fallible.

However, it does create the assurance that a pursuit of certain aims will not be stifled by a governing body, in the case where all the conditions are realised, so that law rather than stifling freedom allows it to flourish. Here Hayek makes a distinction between the rule of law which enables a government to fix conditions in which resources are used, but the ends they meet is ultimately decided by the individual, and arbitrary government where it directs the means of production to particular ends.

Central planning cannot allow the first to exist, in that the formal rules we have provide a framework rather than step by step guidance, central planning would require these rules to be exact in what they suggest in that the particular ends are met, and it is not by the individuals whim the product of these means. Here arises another problem with central planning and as such collectivism. When a government has to make every decision framework rules are useless, imagine trying to solve at this very moment how many buses should operate. Whereas in our current society the government provides the legal framework for their operation but it then comes down to competition, market forces, etc. which decides the operation of buses. A controlling government would have to make this decision under the circumstances that the problem arises, and this means that it would have to balance all the different aims and needs at that given moment as to not favour one, but inevitably somebody’s views have to be given greater significance.

Hayek uses the example of the Highway Code, which does not instruct people on where to go and exactly how they go about it (planning attempts to do this), it instead offers a framework in which the individual can operate but also ensure that society is not harmed, and is better off on the whole. It is here that the concept of formal rules is developed, in that we create rules that are useful to a yet unknown people, under circumstances which cannot be foreseen in detail.  They are formed on the basis that society is better off due to their existence. Thus, this avoids the need of dealing with each individual’s means and ends, the recognition that precise results are hard to come by, and that by providing a structure of which everyone is aware of, everyone will be better off.

Micromanagement is unsuccessful as concrete rules for a given situation would have to be applied, but we lack this information, and in the ultimate end only one aim can be pursued as otherwise it may conflict with another. Thus Hayek notes that the state should confine itself to providing rules to general types of situations as only the individual currently in the current circumstance possess the correct information to make a viable decision. Also there is the recognition that we cannot see into the future, the state would struggle to see the effect of certain actions on particular people. Furthermore, the state chooses between the different ends consequently favouring one over the other, as it cannot know what would have happened if the other aimed were to be picked. Thus planning in regards to law in the creation of definite rules means that it perpetuates the problem of asymmetric information, whereas formal rules reduce the asymmetry’s influence.

Hayek emphasises that as planning becomes increasingly extensive the struggle in asserting what is “fair” or “reasonable” increases. Providing the need for more authority in making executive decisions, and that this facilitates more deliberate discrimination between the particular needs of different people. It would ultimately determine how “well-off” a certain person will be compared to another, in that only one’s needs are met through this discrimination in choice. The rule of law in a non-planned system ensures that there is an absence of legal privilege. Hayek establishes the paradox that in aiming for equality it is necessary to facilitate a legal system in which not everyone is equal in front of it.

“To produce the same result for different people it is necessary to treat them differently.”

The rule of law undeniably can lead to economic inequality (but to some extent this is the only thing that is truly inevitable), thus socialism protests against “formal justice” in that judges are too independent for example. Hayek ascertains that the rule of law is only effective if it is universal and as such does not work in socialist system, in which again there is the breakdown of political freedom. “It does not matter whether we all drive on the left or on the right-hand side of the road so long as we all do the same.” Rules are meant to enable us to predict each other’s behaviour to a needed extent, in that I won’t drive onto the motorway and find that people are driving in the opposite direction.

The individual should be able to foresee the actions of the state on the basis of the rules of law, and as a consequence use this knowledge to form his own plans and how he goes about his affairs. Here the individual knows where the state can stifle his efforts, and that it is not set arbitrarily on the specific circumstance of that moment. From this Hayek makes an acute reference to the Enlightenment:

“Man is free if he needs to obey no person but solely the laws” – Immanuel Kant

In a socialist system the rule of law will be applied in a manner which is as if a person were to be commanded by another. Legislation in a democratic government is confined by the continued discourse and disagreement, whereas in a socialist system in will be pushed through ultimately serving one individual’s ends at the cost of another.

When a state embarks on the complete control of economic life the significance of minority rights, and individual rights are diminished, without even breaking the rule of law at times. Hayek states that ruthless discrimination occurred through a change in economic policy first before and statutory change. Due to the nature of Socialism and the need for an overriding decision to be made, power lands in the hands of few and in that there is the inevitable service of their vested interests, or an ability to go against a large minority.

The “Inevitability” of Planning

There was an argument for the inevitability of planning for example technological change bringing about the existence of natural monopolies, consequently requiring government planning as to some extent the lesser evil than production by private monopolies.

Hayek breaks down this argument once more by considering social infrastructure and existing policies. He asks the question whether the development of natural monopolies is a consequence of new technology, or more simply the economic conditions in which they operate. Hayek argues that the latter is true. He uses the breakdown of the following example:

A large firm having superiority over a small firm, due to technological change may result in greater economies of scale, and an as such lower cost per unit produced and thus begins a process of underbidding and driving out small firms in order to increase market share.

Now at first glance the argument stated above is reasonable, but Hayek notes how this is not the case from a congressional report by the temporary national economic committee in that it states:

“The superior efficiency of large establishments has not been demonstrated; the advantages that are supposed to destroy competition have failed to manifest themselves in many fields. Nor do the economies of size, where they exist, invariably necessitate monopoly.”

This leads Hayek on to argue that it was the policies within countries which facilitated the growth of monopolies, which would then drive out smaller firms. He takes the creation of cartels, and syndications as a consequence of governments seeking regulation in prices and sales as the factor that led to the growth of large monopolies. This goes back to his overarching argument of travelling down one road completely or not at all, as there is greater flaw in attempting a mixture. Then going on to state that “monopoly capitalism” became acceptable even more so as countries such as the United States erected protectionist policies and pursued semi-isolation. He uses the example of Great Britain in stating that planning is not inevitable, in that yet again policy had promoted the growth of natural monopolies. He notes that the British system had been extremely competitive up until 1931 where similar to America protectionist policies arose, and economic planning was introduced and thus monopolies came about. Not of technological change, but the actual structure of the economic system.

He then delves into another segment where planning is not inevitable. Arguing against those who make the assertion that the complexity of modern industrial civilisation creates the need for central planning otherwise we cannot combat its problems effectively. They additionally state that it is increasingly difficult to obtain a coherent picture of economic process, thus things should be coordinated or else dissolve into chaos.

Hayek breaks this down by simply stating that if conditions were simple enough for one person or board to have perfect information then planning works, but as they note in their own argument there is this existing complexity where it is increasingly difficult to attain this information. Thus Hayek argues that decentralisation becomes imperative, as then there is the coordination between separate agencies to bring about “mutual adjustment”. Furthermore, he states that “nobody can consciously balance all the considerations bearing on the decisions of so many individuals.” Thus he arrives at the price system and how it operates without the need for recording every single change in information by a central body. It also allows for the greater complexity in our system which helps the growth of the industrial system and that planning ultimately stifles it.

It is here that he comes to point which is of particular interest to me, he writes about how technological change can be stifled in order to maintain the status quo. For example the industrial revolution promised to enhance the productivity of labour; however it came at the cost of employment for many people. So here arises the argument for the need of central planning to efficiently create the change over such that the short term loss does not override the short term gain. To this Hayek states that planning is not needed as either the short term loss can be accepted, or the change can be delayed up until the necessary infrastructure or policy is erected to minimise any loss.

Specialisation & the Allure of Planning

Hayek states there are many good things, which all agree are highly desirable, and possible, that are difficult to achieve within our own lifetime. This develops the allure of planning in that it seems possible to circumvent the barrier that is time, collective action leading to the achievement of these goals.

He then brings this into regards of specialists (technocrats) in that a planned society seems to offer a route to achieving their objectives. He states that this is an illusion and a misdirection of resources, in that the specialist will obviously place greater importance on his aims then others. Hayek uses a nice example to illustrate this:

“The lover of the country-side who wants above all that its traditional appearance should be preserved and that the blots already made by industry on its fair face should be removed, no less than the health enthusiast who wants all the picturesque but insanitary old cottages clear away, or the motorist who wishes the country cut up by big motor roads, the efficiency fanatic who desires the maximum of specialisation and mechanisation no less than the idealist who for the development of personality wants to preserve as many independent craftsmen as possible.”

However, they all have a wish to go about this planning and therefore they will ultimately come into conflict with each other. As such this brings about the central issue, that not everyone can be pleased. It’s attractive to those who have devoted their lives to a single task and want to see it done universally. But practically this cannot occur, also defining to some extent the authoritarian nature of central planning, only one direction can be pursued and thus not everyone will be pleased.

Is it the End of the British Breakfast?

Now I wanted to start this with a clever pun about jam or marmalade and the British Breakfast. Alas, I have yet to find one, but this story is arguably humorous enough in itself. I awoke this morning to a story on the BBC about a vote in parliament that will take place on deciding the minimum sugar content of jam and marmalade. If trivial micromanagement is a phrase that comes to your mind, I agree. I was arguing with myself over whether this was the government simply making a non-issue an issue, or if there was a genuine problem which required the government to spend time taking this into consideration.

Well according to Tessa Munt “it is the end of the British Breakfast as we know it” (let me quickly moan about her choice of calling it the British Breakfast, even the globally it is known as English Breakfast – Twining’s even have a tea named after it); now this is possibly a little farfetched. Now let me just establish what is going to happen in regards to this law passing through, British manufacturers will be able to reduce the amount of sugar in jams and other preservatives. It was set at 60% now to be lowered to 50% providing a slimmer version of British Jam. Now Tessa Munt has lamented that this will change the nature of British jam reducing its uniqueness and also making it more comparable to French jam.

Here is where things become more trivial, a DEFRA (Department for Environment, Food & Rural Affairs) spokesman stated:

“Reducing the minimum sugar content in jam from 60% to 50% will help British producers – large and small – to trade more easily across the world, boosting our economy and allowing jam-lovers everywhere to enjoy delicious British jam.”

Now there is a big claim here that reducing sugar content will somehow make British jam a more competitive export, and as such will “boost” the economy. Now I see the possible argument that by the use of less sugar, producers will reduce the cost of production by some extent as in place of the sugar is likely to be cheaper substitute preservatives. The question is to what extent will this happen, changing the sugar content in jam and marmalade effects how runny or set the jam is, but ultimately it has been stated that this new minimum will have an almost unnoticeable effect.

I have attempted to find statistics, but I have not come across any data considering the size of the jam and marmalade export market. I am sure it has some significance as there are the royalty approved “Tiptree”, but gut instinct doubts a considerable effect on the foreign market, as it is doubtful that due to this change British jam will no longer be as British. I think if the government is already going to waste time on the non-issue of these foodstuffs it may as well look at the decline of marmalade, and the rise of peanut butter, matching spending at £56 million.

I hope this topic won’t be hotly debated in the commons, if anything it’s a great argument against government intervention, just let the producers decide, and the consumers demand what they want. In my opinion it could not be simpler.

The Decline of European Car Manufacturers

The European automotive industry has suffered over the past three years with declining revenues across multiple manufacturers, and now with growing popularity for Asian car manufacturers there is a greater competition on the pricing of cars, and a grab of market share in a continually diversifying market. PSA Peugeot Citroën is the second largest European based automaker. In regards to market share, the firm was the eighth largest in the world as of 2010. However a decline in car sales, and increased foreign competition, the company reported an annual loss of €5 billion. This goes to exemplify the monopolistic competition nature of the car industry in Europe & America.

Definition “Monopolistic Competition”:

It can be defined as the existence of monopoly power for a firm within a certain period of time in the short run. The firms in the long run will compete on price and other factors (e.g. branding, quality, etc.) eventually losing monopoly power over time as firms begin to differentiate less and create products of homogenous nature.

Main Factors:

• There are Car Manufacturers, No Firm Has Total Control Over Market Price
• Asymmetric Information
• Independent Decision Making
• High Barriers to Entry & Exit

Analysis:

The article goes on to establish the monopolistic nature of the European car industry, and takes a close look at the performance of PSA Peugeot Citroën. The article reveals the monopolistic nature of the market, as it mentions the “sizeable” cash pile the firm maintains, and the fact that the firm reported an annual loss of €5 billion. The graph below displays the current short-run situation that the firm exists in.

The firm is running at a loss because of the declining market share, as there is greater competition from Asian manufacturers such as Kia entering the European market. The Asian firms are taking market share from the smaller range of cars (PSA target market) and then moving upmarket to medium luxury vehicles. European manufacturers such as Mercedes-Benz and BMW have also begun to produce small size vehicles similar to PSA to try and enter this particular section of the automotive industry, as they can use their economies of scale to effectively compete in this partition of the market.

Evaluation:

Another factor attributing to the firm making an annual loss can be noted in the operational cost of the factories. 40% of the firms manufacturing is completed in France, and due to this the firm has to deal with strong unions keeping worker wages high. As well as the influence of the government pushing PSA to keep factories open even though demand for cars has dropped over the past two years or gone over to Asian car manufacturers. The firm can be compared to Renault which is the direct French rival firm, as Renault moved the majority of its manufacturing overseas to reduce the cost of workers’ wages and general operations. The French government has already supported the group with €7 billion in assistance, helping the firm maintain the loss.

PSA’s main rival is the Volkswagen Group, which have an advantage over PSA as they have greater economies of scale. Volkswagen is able to offer consumers similar cars but at a lower cost, this can be noted in the differences between the Volkswagen Golf and the Citroën DS5. The DS5 starting price is £22,700, whereas the Golf starting price is £16,285. This identifies Volkswagens economies of scale, but also identifies another monopolistic characteristic of Citroën since they cannot compete on price, they compete on advertising and aesthetics of their car range. It also establishes the existence of asymmetric information as the Golf has a smaller engine, and less space compared to the DS5.

It is evident that the French firm cannot continue to operate at a loss in the long term as eventually the cash reserves will run out. This means that in the long term the firm may seek government assistance, or it will have to reduce high fixed costs such as factories, and the salaries of workers. This would lead to a reduced unit production and as a result there may be a dwindling market share, but a possible return to normal profit.

The firm is likely to remain loss making unless there is resurgence in the demand for cars, as the market has become increasingly competitive and exiting the market is unfavourable due to the high barriers of exit.

Barriers to Entry, Profit, & Price

Examine The Impact of an Increase in Barriers to Entry on Prices & Profits:

Barriers to Entry: The inability for a firm to enter the market due to infrastructural, legal, cost, financial, and brand barriers. If there is a high cost to enter the market it discourages smaller firms from entering, therefore limiting competition. This is why high barriers to entry are a signal of the existence of monopoly or oligopoly power.

Normal Profit & Abnormal Profit: Normal profit covers the average total cost of the firm, whereas the existence of abnormal profits means the firm can reinvest the profits into R&D, increase the wages of workers, and pay-out dividends to shareholders. Abnormal profit identifies the existence of monopoly or oligopoly market structure.

If there is an increase in the barriers to entry for a given market it may mean that the market becomes:

• Less competitive
• Greater representation of monopoly or oligopoly structure
• Possible increase in profits for firms
• Possible increase of prices, since less competition or substitute goods means that the firm could become a price setter rather than taker.

A comprehensive example of increasing barriers to entry having an effect on prices and profit can be identified in the car industry for hatchbacks within Europe. Volkswagen is notable for their immense economies of scale, therefore posing a high barrier to entry for their share of the market. Volkswagen is able to offer affordable hatchbacks and still maintain a high quality product without incurring a loss and maintaining the majority of the market share. However, their main rival PSA Peugeot Citroën is able to create cars of a similar standard but at a marginally higher price.  These are the two biggest firms in the hatchback market, since they already have a foothold in the market, and successful brand recognition it makes it difficult for firms like Kia to enter the market.

Due to the existence of market power through the high barriers to entry Volkswagen and PSA have an oligopoly like relationship within the hatchback market. Therefore, both firms have abnormal profits and tend to have similar prices while pushing out possible foreign competition. Shown below is a graph exhibiting a kinked demand curve and the market of hatchbacks.

The above shows limited competition on price. The higher marginal cost of PSA can be justified by the lack of economies of scale similar to Volkswagen, meaning they will not be as efficient or productive with given resources. Shown on the graph is the hypothetical point at which Kia were to operate, they would suffer from high marginal costs at a restricted quantity of units due to export/import fees and the cost involved in the transport of the cars. There is also the issue that Kia does not have the same brand recognition as PSA or Volkswagen.

If the barriers to entry were to increase there would be a greater difficulty for the firms such as Kia to enter the European market. This is what establishes the oligopolistic relationship between Volkswagen and PSA. Barriers to entry are what ultimately cause the formation of monopolies or oligopolies. This then has a consequent impact on the prices of products in a certain market (a possible increase) and a greater opportunity to reach a point of abnormal profit through profit maximisation.

Evaluation:

There are various methods of getting around the high barriers to entry, but it would require a firm to either innovate or be able to obtain investors to help launch it into the market. Kia could offer cars with newer technology, better engines, and greater fuel efficiency in an attempt to win market share within Europe. Kia would probably have to compete on price and offer more in a car than the firm’s rivals. Kia will benefit from cheap East Asian production, but there are still issues surrounding the transport of the vehicles. To circumnavigate the high barriers to entry the firm must be willing to take on debt to attempt to pay high fixed costs, or attract investors which would usually require innovation to persuade investors away from the dominant firms.

The diversification of the market for hatchbacks would benefit the consumer, as the firms are more likely to compete on price as well as offer cars with better base packages (i.e. included option in the car such as xenon headlights). However this may create an unsustainable loss for firms like PSA who suffer from a high fixed cost of wages due to its central production being based in France. PSA has already begun to lose its position as the main competitor of Volkswagen as Ford has vigorously entered the market.

Overtime the high barriers to entry may fall as there is greater symmetry of information in the market, as well as the reduction of the impact of economies of scale through the development of new technologies and tools that can produce cars more efficiently. There will always remain however the high fixed cost of the factory, but over time the issue that will affect firm’s profits and the prices of cars will be the variable costs such as where materials are sourced.

This is why the example of the car industry is good for displaying the effect of barriers to entry, and their entailing effect on the price of the good; as well as the potential for normal or abnormal profit within the market.