The Competition Commission has now referred its first Covid-19 excessive pricing case to the Competition Tribunal. The commission alleges that a local manufacturer of medical face masks earned mark-ups in excess of 500% between 31 January 2020 and 5 March 2020, by increasing the price of a box of face masks from R41 to R500. But what is ‘excessive pricing’ and how is it determined?
On 19 March 2020, the South African government issued regulations that prohibit an excessive price under section 8(1)(a) of the Competition Act for certain essential goods and services, ranging from foodstuff and medical supplies to face masks and surgical gloves. During the State of National Disaster, a price is regarded as excessive if it is higher than the price set prior to March 2020, unless it corresponds with higher costs of production.
The Covid-19 outbreak is certainly not the first case where, for exceptional circumstances, there exists “excess demand”, that is, a strong imbalance between demand and supply. Think of war times, oil crises, droughts and subsequent scarcity of grains and so on. When such excess demand takes place, prices may increase substantially, leading to public calls for price controls.
Instruments for temporary price ceilings include emergency regulations (some European countries have issued orders to control prices of hand sanitisers, face masks and funeral services). Existing legal provisions, e.g. in consumer protection, may also be used.
Regulating prices using competition law (alongside consumer protection), as done in South Africa, is unusual. In what follows, I first deal with the pros and cons of price regulation, and then with competition law as a tool for regulating prices.
The possible (adverse) effects of price regulation
The main issue with price ceilings is that they do not solve the problem of excess demand. If prices rise, firms may increase (or start) production, attracted by the possibility of high profits. Suppressing such price signals thus eliminates (or weakens), the possibility of a supply response.
However, supply is not equally responsive for all products. Face masks, protective garments, or certain disinfectants can be produced easily, and in most countries affected by the crisis, production has indeed increased substantially. Here, price regulation would likely be counterproductive. In other cases, for instance ventilators, technologies are complex: price regulations may not hinder a supply response simply because such a response is unlikely, due to lack of infrastructure, inputs, or human capital.
Provided that supply is responsive, it may be possible to stimulate it even without letting price increase above socially acceptable levels, by introducing subsidies, tax incentives, or adopting a guaranteed purchase price through which the government reduces the risk for producers. Admittedly, all such initiatives would increase government spending, but if not during such a crisis and for essential products, then when?
If supply does not increase, there will not be enough of the product available to meet the demand of all those who wish to purchase it. The question is which criterion is used to ration the scarce commodity. A first-come-first-served criterion may be as unjust or inefficient as a situation where (if prices are unregulated), only the rich have access to the product: There is no guarantee that those who get it are those who need it most.
Scarcity may also lead to parallel markets, fraud and criminality: European newspapers these days report stories of falsification and forgery, notably of Covid-19 tests.
When supply is responsive, therefore, priority should be given to ways to increase it, something that price rationing cannot achieve.
Competition law in lieu of price regulation
As mentioned above, using excessive price actions under competition law to (temporarily) “regulate” prices is a novelty. The South African government likely wanted to speed up things by relying on the existing legal framework and on the excellent competition institutions of the country, rather than creating new institutions to enforce price regulations.
At first, excessive price actions may appear as an odd instrument: They require the finding of dominance, and firms that may be accused of price gouging might not necessarily be dominant in ordinary times. However, they may well be in our exceptional times.
Consider markets for food and groceries. Normally, they are defined geographically in a broad way, because consumers can move and shop around. But during a period of confinement, people are obliged to buy their shopping next door, thus becoming captive of local shops.
Even if they have very little market share in a “normal times” market, these shops may be dominant during the crisis. Note that in such cases insufficient supply is not the problem: Some firms may simply take advantage of consumers’ impossibility to shop around. (And here, one cannot argue that price regulations are inefficient: There is no lack of supply.)
In cases of excess demand, even a small firm may have considerable market power. Under normal demand conditions, if any firm tried to set a high price, its rivals would use their spare capacity to undercut it and sell more. But, if at that high price, each firm’s demand is higher than its capacity, there would be no incentive to cut prices. When firms already sell at capacity, by lowering their price they would sell the same amount, but make less profit. In other words, when demand is much higher than capacity, even “small” firms may be endowed with significant market power, that is, they may be dominant.
Excessive prices (unusual measures for unusual times?)
Excessive price actions in antitrust are often criticised because (i) they interfere with the regular functioning of the market, and (ii) they may “expropriate” firms of the fruits of their investment and innovation.
However, under the current circumstances, objection (i) will not apply if supply is unlikely to respond in the short-run; as for (ii), price spikes are due to sudden increases in demand or captivity of consumers and bear little relation to firms’ investment or effort.
Excessive price actions may also create legal uncertainty: It is difficult to establish what price is excessive. For good or for bad, though, the government regulations clearly define as excessive any price above the pre-crisis price (unless justified by higher costs of production).
Using the pre-crisis price as a benchmark is sensible because demand and supply conditions at that time were presumably “normal”. However, in competition law, a price is excessive if “disproportionately” higher than a benchmark. Here, the regulations seem to state that even a price, say, 1% higher than the benchmark would be excessive.
Hopefully, they will not be enforced so strictly, but rather in line with the jurisprudence. Especially because, as argued above, when supply is responsive, a strict enforcement of price ceilings would kill any (badly needed) production increase.
On 15 April 2020, the Competition Commission announced it had referred to the Competition Tribunal the first case of excessive prices under the regulations. A seller allegedly increased the price of facial masks by more than eight times, earning mark-ups in excess of 500%. If facts were confirmed, this would indeed be the type of case that merits intervention. DM/BM