Why a free market is good for LPG
We are told that the market for LPG in Bangladesh is very competitive -- good. It is so competitive that producers are selling cylinders for less than the cost of production -- we should upgrade our response from “good” to “excellent.”
This all being a useful example of why this strange mixture of capitalism and market competition leads to the rest of us all getting so rich. More, it shows us why it is the combination that is necessary, not just one or the other.
There are some 25 firms in the marketplace with another four in the pipeline and ready to enter. The result is that the cylinders are being sold at less than half their production cost in order to hook customers.
We should be careful here -- it’s not the LPG in the cylinders which is being sold at less than production cost, it’s the metal container itself. The one which we bring back when empty and swap for a full one. That is, the entry cost into the system is less than the cost to get us into the system.
So, why is this happening? Well, it’s the result of that good old capitalist greed to profit from selling us LPG combined with many people competing to get rich that way.
Who benefits from this?
Obviously we consumers, we have to pay only half the cost of producing that LPG container. This is a straight transfer from the capitalists owning the company to us, the consumers, wanting the product. This is good, we like things flowing from richer to poorer.
From the point of view of the LPG supplier, this also makes sense. If we have converted to LPG then they’d prefer that we didn’t, every time we needed a refill, have 25 suppliers to choose from.
Thus having to purchase the bottle itself rather ties us into the one supplier over time. It’s not a hard and fast insistence that we may only use the one source but it does impose a switching cost upon us.
The larger point though is that greed -- capitalism -- combined with markets leads to this end result, some part of the profits of the system end up with us the consumers. This is not unusual either, in fact, it’s entirely common across the economy.
To use a different example: An insurance company should lose money if it isn’t generally used. This is evidence that the market for insurance isn’t competitive. For we can indeed run this logic both ways.
Competition should compete away “excess” profits. If there are still these excess profits -- the other name is economic rent -- then we don’t have enough competition. That does mean we’ve got to define “excess” here and the real answer, rather than the formal one, is “more than other people.”
The insight is that all those capitalists out there really are greedy. So, if they see someone making more profit then they’ll think: “Ah, that’s how we do it then,” and go off and try to do the same thing.
Doing the same thing is a competition, therefore those profits will decline. Thus there should be some normal level of profits across the economy. People who are making more than this are getting that excess, the reason being the absence of competition.
This isn’t a new idea, it’s there in Adam Smith from 1776.
So, our insurance company takes in premiums and has to pay out claims. It also has to carry the costs of running the system. It should make a loss doing all of that. For there’s a gap in between collecting the money and having to pay it out.
That money can now be invested and the profits from that investment belong to the insurance company. But if the company can make a profit from investing the money and also from making the insurance policies, then the profits from the entire business will be higher than normal.
Other people will see this, set up in competition, and that will drag back the total profits to the normal level in other businesses. This also works the other way.
The American insurance industry is generally reckoned to not be competitive for those underwriting -- purely from the insurance without the investment -- profits exist.
The reason is that it is divided up state by state rather than being a national market. The English insurance market is held to be competitive as underwriting profits generally don’t exist.
I agree, it seems a bit of a stretch from LPG to insurance. But this is one of the underlying points about the economy. When there is that competition then profits get competed down. And this is what leads to us consumers benefiting from the arrangement.
It’s also why economists are so insistent upon our having that market competition, for that is the part of the system which does ensure that we out here benefit.
We’re the people the system is trying to make rich. So, our system needs to be one of the markets and competitions.
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.