Equality of opportunity not equality of outcome

Recently when I was trying to avoid actually doing work I was wasting a fair bit of time on Facebook.  I have a strangely diverse group of friends on Facebook some of whom are right wing and some of whom are very left wing and it is always interesting to see the articles that people are sharing.

Recently one of the more right wing people put up a video from a US talk show (I think it was on Fox News) where they were espousing the view that in a fair and equitable society that we should all have equality of opportunity and that equality of outcome is actually inequitable because it does not reward effort and hard work.

I have to admit that at one basic level this is an incredibly tempting point of view - who of us has not hated paying taxes, especially when we see how some of it is wasted?  Especially when we see people mooching of the system and then wanting to tax us more even though we are working stupidly long hours and not really getting to where we want to get to.

However equality of opportunity is not as basic as you may think

The problem with the 'equality of opportunity' mantra that is often spouted by right wing pundits is that if you were truly interested in the 'fairness' of the system and making hard work and effort the primary determiner of outcomes and success you would be most interested in making sure that people started at the same point.

People start at different points and have different advantages and disadvantages due to not fault or skill of their own.  If you live in a first world country you already have so many advantages that others around the world do not have.  Then if you are lucky enough to be within a social structure that allows you all the possible opportunities you are most able to make your effort count.

If you are outside such social structures you are not

The Corporate Paradox: Communism inside a Capitalist Entity

I'm sure there is more extensive research on this out there but I was recently struck by a discussion I had with a colleague about the nature of capitalism and the players that act in it.  The crux of this post is that it is a strange dichotomy where the main players in our capitalist system - i.e. the corporations (especially the large institutionalised ones) work more like a communist economy internally while spouting the benefits of capitalism and free markets externally.

In several posts before I have identified as a 'realist capitalist'.  That is I know and appreciate the benefits of free markets and capitalism however I do not think they are perfect and we add enough distortions to the system which means that rational actors do things and act in ways which are perfectly rational from an economic standpoint (such as forming unions).  I think that accepting the rhetoric of capitalism and ignoring it's shortfalls are dangerous and leads to bad policy outcomes.  Besides which - it can be a fun thought exercise.

Corporate entities often work like communist economies

Most people would call me out for being ridiculous for suggesting that the bastion of free market capitalism - the corporation - is more like a communist government than the free market hero they position themselves at.  They may be a free market hero when they are operating as an entity as a whole but if you look through to how corporations (especially large institutionalised ones) actually work...they are remarkably like a communist economy.

You can take this analogy quite far however at a very high level:

• Like communist countries, corporations are centrally planned
• Corporations have a very strict hierarchy of control and the ability for any part of the corporation to act economically independently of another to maximise their own profitability or outcomes is squashed for the greater good of the corporation
• Like communist countries workers within a corporation rarely have an input into their job function
• There is an allocation of labour in corporations based on where the resources are needed and people find themselves often doing things that they originally didn't come on for because that is where they were needed...a system awfully like that of communism
• I'm not saying that you cannot leave the corporation...just that if you want to stay in it you need to play within these rules
• Ideas and independent initiative are subject to approval of those further up the chain 
• How often have you seen employees of a corporation come up with and implement independent ideas without the approval of their managers and how often can they quickly respond to a need or want without this approval?
• If a corporation acted like the free market bastion it claimed to be there would be a maximising out outcomes within the corporation through things like competition and innovation

You can keep going with this analogy for as long as you want - there is a centralised media strategy, only approved people are allowed to set strategy and to message this strategy to the outside world etc. etc. 

Yet corporations are often the most vocal proponents of capitalism

I find it incredibly ironic that probably the most centrally planned entities within our free market economy are the ones that are constantly calling for deregulation and an ability

The free market is not perfect: The case for unions

It has been a while but I thought I would return to one of my pet series of posts which attempts to provide a rational economic explanation for much of what we see around us.  Most people have a basic understanding of economics 101 however this is not enough.

There are those, especially on the political right who advocate the free market as the solution to all our problems.  The believe that market mechanisms are the most effective and efficient means of allocating resources and to the largest extent possible governments should keep out of this.  I believe this to be only partially true.  As I have posted about before, better outcomes often result if governments are around to enforce property rights and intellectual property rights which lead to innovation and better outcomes for society which would not result in a free market.

This time, I am going to stretch the bow a little further (and perhaps drive those free market advocates a little crazy).  I believe that unions are a product of the free market and rational actors and are a natural part of an economy where businesses are allowed to gain market power.

A union is a worker trying to improve their outcomes through scale

All of intuitively understand that the bigger an enterprise gets, the lower it's unit cost of production is.  This is one of the major benefits of scale.  However there are other benefits - if it is able to achieve some form of market power then it can influence pricing and extract monopoly rents from customers.

Unions are rational workers doing exactly the same thing.  They are achieving market power to deal with companies on a more even footing.  The negotiating position of an individual is minimal - you take what you are given (especially if you are replaceable), however the negotiating position of a workforce is formidable - a company cannot fire everybody if they want things made.  Just as the company would seek to extract monopoly rents if they are in a position to exercise market power, so are unions able to extract higher than market outcomes for their members if they have enough power in the system.

This is no better and no worse than the company making the money themselves.  There is often a rhetoric which suggests that it is good for companies to make large profits and it is bad for unions to demand a large share of the profitability of the company.  I do not view one outcome as

Trickle down economics...separating self interest from good policy

I was on Facebook a few days ago when I noticed one of those annoying 'recommended pages' advertisements that look like your friends updates but are actually subtle advertising.  I was surprised to see Gina Rinehart posting a link to her website with what looked like a blog entry entitled "Gina Rinehart is our least controversial celebrity".

I questioned whether even Ms Rinehart would promote herself so blatantly and in such a crude fashion.  I think it is a fan site and I didn't bother reading it - I was much more interested in the comments under the post itself.  What genuinely surprised me was how much support there was for Ms Rinehart on the entries. There was actually far less trolling than I would have imagined and a rather lively debate on whether the policies and views she espouses were good or bad for Australia and how economic policy should work.

Although it was not clearly stated, I was reading a lay discussion about the relative merits of 'trickle down economics'

Trickle down economics is a term which is often used in a negative sense to refer to the idea that if you stimulate the top end of town - e.g. the wealthy and the business community through incentives, tax cuts and other financial means they will be incentivised to expand their business operations.  Although the immediate benefits in the short term go to business owners and those in the wealthier classes, the 'masses' also benefit as businesses are encouraged to hire people which results in job growth, wage growth and everyone benefits.

This is an argument that is seen much more in America than here in Australia and importantly - they have tried it.  During the Regan era policies designed around trickle down economics were introduced.  Here is a good summary from the Rachel Maddow show - the explanation starts around the 2 minute mark.

These sort of economic policies are promoted by conservatives all the time.  However, it is often hard to separate the truth from self interest and this is where my interest in the Gina Rinehart story came in.  A lot of her supporters were big believers in

Negative political advertisements about the economy have ALREADY started

I don't often watch television however happened to have very little to do a few days ago and so noticed something I wouldn't have ordinarily noticed.  The negative political advertisements about the economy have ALREADY started.  They have started before a general election has been called and, like most political advertising, is so biased an inaccurate as to be rather misleading.

For all my international readers, this post will be a complaint about the Australian electoral cycle however you may get some benefit when thinking about advertising in your home districts when you go through election cycles.

What sort of advertisements am I talking about?

I tried to find videos on YouTube which illustrated my point but appears that Australians do not bother enough to put their political advertising on YouTube and thankfully our politicians are not yet internet savvy enough to deploy the full gambit of internet advertising.  Alas, that means that I will need to describe for you the type of advertising I am talking about.

The particular advertisement that got to me was one in which the Liberal party pointed out that the Australian government was running up a deficit of $100m a day in 2009/2010 when Kevin Rudd was last leader of the Australian Labor party.   The implication of course being that with him now back in control, if you vote for him he is going to destroy the economy and pile on the national debt again.

It reminded me of an advertisement a few election cycles ago where the basic argument was that you could not trust the opposition party because every time they were in power interest rates rose, thus if you put them in power again, the interest rate that you pay on your home loan will go up again.

This happens at EVERY election cycle.  And both sides of politics play this game with different issues.  I am particularly concerned about economic policy and the Liberal party is typically the one that runs the advertisements about how the Labor party is going to ruin the economy and look at their past record.  The Labor party does it about other issues such as how the Liberal party cronies up the businesses and sticks it to the ordinary Australian worker.

Why do I hate these sort of advertisements?

I am passionately against any sort of advertising that relies on the fact that your electorate is uninformed and which feeds them a simplistic

The free market is NOT perfect: Property rights improve efficiencies

As outlined in my last post on this topic - 'The free market is NOT perfect: Knowing Economics 101 is not enough' - I will be doing a series of posts rebutting the claims of free market advocates masquerading as 'libertarians' that we would all be better off if the government was not involved in the free market.  Indeed the only way to create a more efficient society where everyone is better off is if the government stopped getting involved.

These points of view have been gaining momentum in recent times, especially in the United States, although I have noticed more and more people starting to join libertarian type organisations here in Australia as well.  Indeed, in the lead up to an election, these voices tend to get significantly louder.  I will be rebutting many of their claims in the coming weeks - however I am by no means left-leaning in my preferred economic outlook.  I believe that market mechanisms are broadly the most efficient because they most closely play to the human condition.  However I believe that the market is NOT perfect and that regulation and intervention is needed to maximise efficiencies.

If you want a truly free market...give up property rights

Free market advocates and the libertarian strain of these in particular rail against rules, regulations and government intervention in the operations of the markets claiming that all this does is create inefficiencies.

Fine libertarians...if you don't like rules and regulations then the first thing I want you to give up is property rights and see what that does to market efficiency.

Property rights form no part of a true free market economy.  By property rights I mean the right to

• Intellectual property rights including
• Patents
• Trademarks
• Physical property rights

If you truly want a free market

Emissions Trading Schemes...why would a conservative party oppose it?

If you live in Australia you will know that the Prime Minister, Kevin Rudd, announced that he wanted to move from a carbon tax to an emissions trading scheme (ETS) next year.  What was baffling to me, was the response of the opposition leader, Tony Abbott who is looking (according to the polls) like almost certainly being Australia's next Prime Minister.

I suggest reading this article for a brief overview on the comments made by both parties and I will do a brief overview of why I think Mr Abbott is just playing politics and assuming the Australian voter is exceedingly dumb.

Emissions Trading Schemes internalise negative externalities

Negative externalities are those outcomes of the 'free market' which are bad, however which are generally not taken into account in the price of the good or service being produced.  In the case of energy for example, coal is the cheapest form of fuel in a private sense (i.e. to dig out of the ground and to burn) however there is a social and environmental cost to this which does not get included in the price of coal.  However there is a very real cost to this which is borne by society in terms of environmental effects which need to be fixed / cleaned up by future governments and taxpayers.  This is what is known as an externality.

Note that externalities can be both positive and negative however they both face the same problem in a market economy - the benefits of positive externalities and the costs of negative ones are not included in the price of that product.

The solution to externalities is to try and internalise the cost or benefit in order to reflect the true cost of the product.  This often has to be done via regulation (especially in the case of negative externalities) as profit seeking enterprises are never going to voluntarily give up the lower private cost / higher social cost item.

An emissions trading scheme is a market mechanism to internalise the cost of carbon for those who pollute and it also offers 'credits' for those who do not pollute (e.g. for those who use or create renewable energy).  It is the right-wing, market method of accounting for a cost where the market fails.  A left wing measure would have been to put a tax on the product which

The free market is NOT perfect: "Knowing" Economics 101 is not enough

I have been thinking about this topic for a while actually and have spent the last week writing down my thoughts on it on various scraps of paper because I thought that I could make it into a series of posts which outline why I am not, nor have I ever been, a believer in the free market.

This may seem strange coming from an ex-investment banker, turned investment professional and also as a person who writes a blog tracking their wealth journey and sharing what my goals and aspirations are.  However I should state up front that government control is a sliding scale - an economy is NOT either free market capitalist or planned socialist.  There is no pure free market capitalist economy in the world just as there are very very few remaining planned socialist countries in the world.

Why did I start thinking about this?

I was motivated to think about this issue when I was watching some clips about the Tea Party movement in the US.  The whole movement struck me as fundamentally odd...the people protesting and joining these movements looked like those who most benefited from government programmes and assistance.  I also wondered about the economic policies and catch phrases that right wing politicians and free market advocates often throw out there which are so simplistic that they are effectively wrong.

And then it struck me...most of the general public has some appreciate of basic economics - they can see, think about and visualise simple economic concepts in a very real way around them.  However I do not believe that most of this same public has an innate understanding of the assumptions that underlie these 'simple' principals nor the consequences of what they are asking for when they demand a free market economy.

As I was thinking about how I would approach this series of posts though, one of my economist friends sent me a link to this article which explains how and why Econ 101 is killing America.  It is one of the best and most succinct articles I have ever seen.  It busts many of the myths that the general public has in their mind.  I highly recommend reading it.

Why does it matter?

It matters because as these movements start to gain steam and momentum, politicians and policy makers start to take notice.  There are some who would

The share market has gone mad...when bad news is good news

The financial markets and the investment world generally has gone mad.   When bad news is good news in the stock market and I see headlines in the financial news saying that the stock market rallied on weaker than expected financial news or that it was weaker on better than expected news you know that the markets are not working in their proper way and that something out of the ordinary is happening.

Even if you do not follow the financial markets closely you cannot have failed to notice the stock market tanking over the last month.  Indeed most major stock markets have lost the strong gains they have made since the start of the year.  One of the major causes of this was an announcement by Ben Bernanke of the US Federal Reserve that the economy was recovering to such an extent that they would consider starting to roll back QE3.

A recap on QE3

When QE3 was first announced I posted about it, what it was and why the share market reacted so strongly to it.

In brief QE3 was the US Federal Reserve printing money and buying back US Treasuries and mortgage backed securities to provide liquidity in the market

This was to force down interest rates and force lending to start as the yields on these products were depressed to levels so that people would have to invest elsewhere.

QE3 was only ever going to be a short term measure! 

You cannot continue printing money into infinity in order to provide liquidity in the market.  It was only going to be a short term measure to get the economy kick started again and guess what?  It worked.  The US economy started to recover strongly with economic growth rebounding and the share market reflecting this

So why did the market react so negatively towards the announcement that it would be scaled back?

I personally think that much of it has to do with how short term investment managers and profit makers are these days.  In the short term you would expect the share market to pull back as yields recover

How will the Australian 2013 - 2014 Federal Budget affect you?

The federal government's long anticipated 2013 - 2014 budget was released last night.  It was always going to see what the government did given:

• It is an election year and the Gillard Government is well behind in the polls
• Tax revenue and income to the government has fallen off a cliff with the slowing economic environment

I confess that although I am not particularly drawn to any political party, I have found the Gillard Government's fiscal policies to be frustrating and spineless.  This is probably a function of the hung parliament they have had to negotiate but it was nonetheless very frustrating.

From my point of view this budget surprised me - it was pragmatic, invests in Australia's future and does not do the pork barrelling and vote grabbing that most election year budgets do.  We are all going to be a little worse off but I do appreciate having a government that is willing to acknowledge that we are in a worse economic position now than we were a year ago and that does not spend just to grab votes.

So how will the 2013 - 2014 Australian Federal Budget affect you?

Like all things...it depends.  There isn't really something for everyone in this budget.  From an individual point of view there are not a great deal of positives and some negatives but it really has to do with how much you are already getting from the government (or not getting).

The benefits in the budget for individuals

• $14.3 billion in funding for the national disability insurance scheme
• If you have a disability this will definitely benefit you
• If you do not have a disability you may be disadvantaged through the increase in the medicare levy - see below
• Increased funding for public schools and education
• This will benefit the quality of educational institutions but there will be no hand outs to individuals like in the past
• I'm not against this at all - I think a good system is much better than giving people choice about where to spend their education dollars
• Note that this is for primary and secondary only...tertiary education did not get the same level of funding benefits
• Seniors funding
• $112.4m to help seniors who are downsizing their homes

The rest of the benefits do not really impact individuals at all - they are all about nation building.  It is about infrastructure (roads, rail) and other measures that only a government can fund.  If you're going to try and improve a country and an economy in the long run this is are the types of things that need to be funded.

Personally I got no real benefits from this budget but I'm just glad that we finally have a government that is thinking about the long term.

The downsides for individuals

• The baby bonus

What is QE3 and why did the share market react so strongly to it?

If you follow the share market at all you will have noticed that there was a major spike towards the end of last week as the US Federal Reserve announced that it would undertake QE3.  This post is a quick background for all those who were wondering why the market spiked so much last week and what the impact of QE3 will be going forward.

QE3 actually stands for a form of unconventional monetary policy known as quantitative easing.  The quantitative easing announced on Thursday last week was the third time the Federal Reserve had announced this policy would be implemented (and hence the 3)

What is Quantitative Easing?

As mentioned above quantitative easing is a form of monetary policy.  Normally when an economy is slowing or inflation is well below central bank target levels, the central bank (or Federal Reserve in this case) will step into the market and reduce interest rates to help stimulate demand in the economy. 

The problem that the US Federal Reserve had was that it had already reduced interest rates to effectively zero which means that they could do nothing further on this front to help stimulate demand in the economy.  Given interest rates can be changed on very short notice the Fed had even tried to extend the period which they were committed to these low interest rates (currently they say they will keep them low out to 2015).  This still did not have the desired result and so interest rates are effectively useless now.

The US Fed then turned to quantitative easing.  The basic idea of quantitative easing is to print money and use that money to buy back US Treasuries and mortgage backed securities to provide liquidity in the market.  The basic hope is that with the excess of capital now in the market that investments will be made in 'real world' assets or on consumption and so stimulate growth and fix the economy.

Why does it involve buying US Treasuries and mortgage backed securities?

Using the money to purchase US Treasuries and mortgage backed securities is a function of the current financial crisis

• There has been a general 'flight to safety' where money has flowed to those assets deemed most safe in the markets.  If you have a look at the yield on US Treasuries it is clear that this is where a lot of the money has been flowing.  The Fed's aim was to move some of this money out of US Treasuries by buying these bonds back and hopefully people will allocate their funds elsewhere in the market
• The market for mortgage backed securities is still very weak and people do not want to be buying these assets.  By providing liquidity for these markets it is hoped that funding will return to these markets so and effective borrowing costs for homeowners will come down

Why did the share market react so strongly?

There are several reasons the share market reacted so strongly:

• It is a pure demand / supply outcome.  If you have billions of dollars flowing into the market which have been created out of thin air then this increases demand for the same supply of stocks thus increasing the general level in the market
• It provides confidence  in the market.  There are some who believe that this is the first step on the road to recovery.  That the inflow of funds will help right the state of the US economy and that things will return to normal.  I am less confident about this.  Given this is the third time that the US Fed is introducing quantitative easing it suggests that the strategy is not all it is cracked up to be.  There is a downside as well - market participants start to expect this level of involvement from the government and when and if it stops the market will return to 'normal levels'

The outcome from QE3 is far from certain.  Over the last week we have seen the dust settle after the furor created by the announcement and general market sentiment and share prices start to pull back.  Perhaps it will be this round of quantitative easing that works or perhaps the Fed has done nothing more than create inflation through the printing of money.

The Big Short by Michael Lewis

The Big Short by Michael Lewis, author of Liar’s Poker, is a well researched, although obviously biased, look at sub-prime debt crisis and the factors that led up to it.  The book has been on several best sellers lists and for good reason – it is the best book that I have read on the topic and is interesting even if you do not know anything about CDO’s, subprime debt, the US housing market and all the other factors that led to the crisis.

Although the book primarily focuses on the hedge funds (including a fund that was seeded by Joel Greenblatt, author of You Can Be a Stock Market Genius which was been previously reviewed on this site) that saw the crisis coming and made significant money out of it, Lewis also looks at the other players in the market including the buyers of the mortgage backed securities, the buyers of the credit default instruments, the investment banks that were pedalling the goods to everyone and the ratings agencies who were probably the reason that the whole thing came undone.

The strength in The Big Short is on Lewis’ ability to distil quite complex products and topics down to rather simple explanations of how they work and the relative pros and cons of either side of holding the product.  Also I liked how Lewis broadly arranged his books into time periods and then looked at that particular time period from every angle (i.e. pre-crisis when no one realised there was a problem, when people started to realise the issues, when the crisis became public knowledge etc)

As a last point of note, when I read this book I read it from the perspective of an investor (as that is what I do for a living).  However I was chatting about it to investment bankers who really focussed on the failings of their business model and incentives.  Again when chatting about it to those who have nothing to do with the financial industry the focus was on how the system failed.  There are so many different ways to interpret the lessons from this book and it all depends on the perspective you are reading it from.

Pros

The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb

The Black Swan is all about being aware of those things that we don’t know, can’t predict and which are likely to have a large impact on our lives (what Taleb calls the ‘Black Swan’ event).   This book will change the way you think about the world and the way in which it operates.   It covers a broad range of topics all attempting to prove Taleb’s central idea that the future is unknown, any attempt to predict it is inherently flawed as the next big thing to influence our world (e.g. the computer, the internet, September 11) are all inherently unknown.

This book has lessons for everyone but is especially interesting for investors and those interested in finance generally.   Among the broad variety of topics covered some of the most interesting are:

·         Forecasts are inherently flawed (especially over the long term) – how can you tell what is going to happen in 20 years time when you have no idea what innovations are going to take place in that time? (i.e. an example that the book uses is that in the early 1990s US government departments were using long term oil prices of $27 a barrel as a forecast assumption).  Also note the impaction the above has for temperature prices in the context of global warming (or climate change as it is now called)

·         Statistical inference from past events is also flawed as it does not consider the effects of the high impact unknown event.  To illustrate this Taleb uses the example of a turkey that is fattened up every day for its whole life – the turkey will assume that based on the last 1000 days of its experience it should be fed into the future (and we all know what happens around thanksgiving).  I found this particularly interesting especially when you view this idea in light of what happened to Long Term Capital Management (see my review of When Genius Failed here)

·         Modern finance is steeped in the idea of the bell curve which is based on a set of quite restrictive assumptions and historical experience – six sigma events are relatively common in finance markets (more than should statistically be the case anyway) and investors should not the probability of these at all times

·         So much of life (and financial success) is largely a matter of chance, however if you put yourself in chances way (i.e. those areas which have limited downside but are in the right spot to benefit from a positive black swan) then you are more able to take advantage of the black swan

Given the amount I obviously enjoyed the ideas in this book you may be wondering why I gave it such a (relatively) poor rating.  The reason is simply that this book needs to win some sort award for rambling and straying off topic.  I got bored and frustrated at this book putting it down at least 10 times before I could be bothered going back to it again.  The book feels like no one read it over before they hit print. 

Book Review: Freakonomics by Steven Levitt and Stephen Dubner

Freakonomics was the hit book that brought economics and economic theory to the masses in an interesting, witty and oddly trivial fashion.   The book is a great read for those who are new to economics as it is easy to read and simplifies economic theories quiet well, and it is an eye opener for those who have studied traditional economic theories in the various applications that it can take.

The primary author of the book is Steven Levitt, a chaired professor of economics at the University of Chicago.  He is probably best described as an empiricist who uses his economic background to answer interesting (though sometimes seemingly trivial) questions.  In Freakonomics he uses economics to answer a wide variety of questions including:

• What do schoolteachers and sumo wrestlers have in common? (They sometimes have very strong incentives to cheat – and evidence shows that they often do)
• How is the Klu Klux Klan like a group of Real Estate Agents? (The power of information is on their side)
• Why do drug dealers still live with their moms?
• Where have all the criminals gone? (Probably the most controversial point in the book.  Levitt argues that the fall in the crime rate in the US has a direct link to the introduction of abortion in the 70s.  Personally I don’t subscribe to this view though his use of data is compelling)
• What makes a perfect parent? (What child rearing strategies have an impact on grades in later life)
• How does naming affect children in later life?

As mentioned previously the topics covered above seem rather trivial and are probably not going to win Levitt a Nobel Prize any time soon.  However for a light read on a weekend or if you’re really looking for some real life application of economics then this is a great book.

Pros

• Easy to read and understand.  There is no complexity here and Levitt and Dubner have gone to significant effort to ensure that most readers can understand what they are trying to say.
• Easy to put down and pick up again at a later point.  You can read this book in one setting or simply pick it up and read an odd chapter – there is no prior knowledge assumed anywhere in the book

Cons

• The topics covered are generally pretty trivial.  You will not learn anything that you can apply in your life however economics is generally like that so perhaps we should not be surprised.

Price discrimination: The Audi Arbitrage

Last week I posted on price discrimination and how Australian consumers often get charged much higher prices compared to international counterparts for exactly the same product.  I also posted about how people were getting around price discrimination by parallel importing products themselves into Australia (which is prefectly legal).

So far the consumers in Australia have only really been buying those products which are easily shipped by airmail to Australia (the evidence is in the massive increase in business Australia Post has seen through it's parcel delivery service) however I wondered whether this trend would catch on with products that were larger and much harder to import.  One of my friends is in the market for a new Audi A6 and he claimed that after looking at the US prices that it would probably be worth importing a car himself from the US rather than buying it from the dealer here.

I was intruiged by the idea and so decided to calculate whether there was an 'Audi arbitrage' available.  It's not technically a true arbitrage because I am not shorting an Audi at the Australian price (though conceptually you could enter into a contract to sell someone an Audi at the Australian price and then import one from overseas).  However the principle is what I am interested in.  For the purposes of this discussion I am going to ignore the left hand / right hand drive issues with importing from the US.

The Audi Australia website was good enough to break out the manufacturer price plus all the extras which I have outlined below.  Note that I am comparing the A6 Sedan Petrol 3.0 TSFI.

Item	Cost
Manufacturer List Price	$106,773
Dealer Delivery Charge	$3,636
Luxury Car Tax	$15,883
Registration (Vic)	$748
Stamp Duty (Vic)	$6,320
Drive Away Price	$133,360

The exact same product is available on the Audi US website here.  There is no convenient break out of all the relevant 'add-ons' so I used an estimate of the doc fees from this website and took the highest value (i.e. $610) as a drive away price.  I have converted at the approximate current exchange rate of AUD/USD 1.01 and have added on all the possible extras I can think of to get a landed price in a Australia which I have listed below:

Retail price differences across countries: economically sound...but very annoying

There has been a lot of press lately about the extent to which international congolomerates charge significantly different prices in different countries.  In fact it has become such a politically hot topic in Australia that the government launched an investigation into the issue and are holding parliamentary inquiries into the topic.  The Austrlaian Productivity Commission released a great report in 2011 which spelled out why there are pricing differences between different countries and it is definetely worth a read.

Retailers often try and explain the difference away by talking about higher minimum wage standards, the highest retail rent costs in the world, high costs to ship to Australia as well as high taxes.  Savvy consumers though have pointed out that even when you take these into account Australians still get significantly charged more for exactly the same product than overseas consumers do.  Actually the big issue is that (and this is spelled out pretty clearly in the Productivity Commission's report above) wholesale prices for Australian retailers are much higher than those incurred by retailers in other markets.  Thus it is the multinational manufacturers who are causing the significant price difference that Australian consumers face.

For anyone that has studied economics however the fact that companies that operate across countries charge different amounts for different products should not come as a suprise to anyone.  It all has to do with price discrimination which is charging different prices to different consumers to the same product.  This actually occurs all the time, you only have to look around you to see lots of examples such as:

• Discounts for seniors for the same products
• Concession rates for students
• Cheaper rates for those who choose to buy in bulk
• Cheaper prices on the same product but 'cheaper stores'

The common rebuttal to most of the above is that they get cheaper rates 'because they cannot afford to pay as much'.  Actually this is exactly the right answer - it all has to do with willingness to pay or what is also called elasticity of demand.  A full wage earner is willing to pay more for the same product for a senior or a student so if you as a seller can sell at one price to one consumer and one price to another you can maximise both demand for your product and the price you recieve (thus maximising your profits).

Thus companies that charge different prices to different countries of customers are doing exactly the same thing which as I mentioned above makes complete economic senese.  However the system only works as long as those who are paying the higher price have no way of buying the good for the lower price.  In traditional price discrimination companies use things like seniors / concessions cards / volume to seperate the lower paying customers from the higher ones. 

The current fly in the ointment for these companies though is parallel importers who make a profit by buying at the lower prices overseas and then selling over the internet into Australia.  Australian consumers are obviously loving this and helped by the exchange rate at record highs have been buying from overseas in larger and larger quantities.  Companies have responded by trying to ban their retailers from selling into Australia but have run up against competition issues (i.e. you run afoul of the competition laws in Australia because you essentially are forming an agreement to keep prices higher).

By doing this the companies have also put consumer offside.  Consumers now realise that they are being overcharged.  I think to some extent consumers are blaming the wrong people.  The people to blame are the multinationals not the Australian retailers.  It will be interesting to see where the issue ends up.  In the mean time I will continue to import my goods from overseas and avoid Australian retailers completeliy.

Next week I'm planning on doing a post seeing whether I can financial import a luxury car into Australia and save tens of thousands of dollars.  One of my friends sent me a spreadsheet which says it can be done but I'm going to test his assumptions to make sure.