The Productivity Commission’s recent report on competition in the financial system raises major concerns about the market power of the big banks. “[L]arger financial institutions, particularly but not only in banking, have the ability to exercise market power over their competitors and consumers,” the commission concluded. But there’s a key issue missing from the commission’s analysis, reflecting that the commission, for all its independence, struggles to move beyond traditional economic thinking.
In an influential 2017 paper, US finance professor Luigi Zingales considered what happens when firms become so large that they begin to rival states in their political power.
… in contemporary economics, the commonly prevailing view of the firm ignores all these elements of politics and power. According to this view, the firm is a simple “nexus of contracts”, with no objectives or life separate from those of its contracting parties… it does not accurately describe the giant global corporations. The largest modern corporations facilitated a massive concentration of economic (and political) power in the hands of a few people, who are hardly accountable to anyone.
And as the US economy has become more concentrated and corporations bigger (evidenced by increasing margins), that power, and the ability to exploit it against customers, workers and politicians, has only grown. Much of Zingales’ article explores the ways that US firms have used their power to obtain regulatory outcomes they want. “The greater their market power, the more effective they are at obtaining what they want from the political system. But the more effective they are at obtaining what they want from the political system, the greater their market power will be.”
This sits poorly with traditional economic thinking, which assumes corporations face competitive markets or, even without competitive markets, the threat of market entrants. One of the characteristics of neoliberal economics has been the effort of neoliberals to justify diminishing competition as firms grew bigger. Neoliberals justified mergers and acquisitions that created giant, market-dominating corporations as achieving huge efficiencies and savings that would flow through to consumers. The reality, of course, was very different.
Australia’s financial system has been a near-perfect demonstration of Zingales “political theory of the firm”. The major banks have wielded political power to protect their own interests. Successive Liberal ministers responsible for the financial system — Arthur Sinodinos, Josh Frydenberg, Kelly O’Dwyer — have been former bank executives; there are strong relationships between senior Liberals, the big banks and the Business Council, and the Liberal Party fought tooth and nail against Labor’s Future of Financial Advice (FOFA) reforms in opposition, then cut funding to ASIC and sought to repeal the FOFA reforms once in government.
The banks’ political power was used to preserve the integration of the banks with wealth management and financial advice services that enabled the banks to siphon off billions of dollars in fees from superannuation clients in retail funds. The royal commission has only really detailed what we have long known was happening for more than a decade: the conflict of interest inherent in this vertical integration model has harmed consumers. As the commission notes, “vertical integration also appears to have created a competitive advantage for the largest financial service licensee groups in promoting in-house products over competitors’ offerings. Here, enforcing the conduct standards required in the financial advice market is pivotal to competition and ensuring the client’s best interest are met.”
The Productivity Commission’s analysis overlooks how vertical integration was protected by the political power of the banks, who sought to undermine reforms that threatened vertical integration and ensured the principal consumer protection agency in financial services, ASIC, lacked both the will and resources to pose any sort of regulatory threat to the banks. Indeed, the origin of the current ASIC was another demonstration of the political power of the banks: it was the Liberals under John Howard that gave an underfunded and toothless ASIC the role of protecting consumer interests in the finance sector, rather than the ACCC, in the wake of the Wallis Inquiry in the late 1990s — removing a major irritant to the banks in an aggressive and litigation-ready competition regulator.
The commission is normally willing to grasp the nettle and criticise politicians, albeit indirectly, but the political dimension to market power has eluded it on banks.
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It’s true now that the Liberals have changed their tune dramatically on the banks, but that serves only to demonstrate Zingales’ point: it was political calculation that drove the Liberal Party’s shift, demonstrating the essentially political nature of the power the banks wielded. Any assessment of the market power of the banks is inadequate without an assessment of the political dimension of that power, and the way in which it has been used to benefit banks and harm consumers.