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Competition in these markets, therefore, is unlikely to be on the basis of product innovation. Service innovation is possible to some degree with the Internet, but there are only so many ways to deliver insurance -- it is a product centuries old and not subject to much innovation. In a market like this, service and price are two methods of gaining competitive advantage. Private insurance firms use proprietary actuarial tables to set rates, and this might be the only way that an insurance firm can gain advantage, since it is nearly impossible to derive sustainable competitive advantage from service. Thus, profit margins are slim and a firm can improve the spread between the table and the consumer price only by increasing volume. This leads to a price war as firms fight for market share. Knowing that price wars are devastating to businesses on already thin margins, the companies in the industry instead begin to spend on marketing. In addition to insurance in Europe we see this in a number of telecommunications markets, and frequently in the global beer market, among other industries. Products and services are not differentiated because the firms in the industry cannot conceive of how to do so, so they spend extravagantly to outmarket each other. Since they all do it, they all pass the same costs onto customers.
What this shows is that for some industries -- and it depends on the specific industry characteristics -- the nature of competition may lead to higher prices rather than lower, particularly if extensive marketing is considered by the industry players to be the main way to improve market share. Government monopolies, of course, have little need for marketing since their audience is already captive. Thus, they can be profitable at lower price levels…and they are not always trying to do anything more than break even.
Impact on Consumers
Orthodox economic theory holds that consumers will see a range of benefits from competition, not just lower prices. This assumption, however, derives from the assumption that firms within an industry will compete on a number of different levels. However, in some industries we know that not to be the case. The result is that competition does not have any marked benefit to consumers. The reason that governments become involved in some industries is because they consider the product or service to be a public good. Generally, public goods are characterized as having benefits beyond simple economic outcomes. Insurance, for example, standardizes the terms of insurance and can improve the quality of coverage because the government is motivated to deliver a high level of coverage, not just a low cost of coverage. Backed by the government's resources, this is entirely possible for a government-run insurance company.
That competition does not always deliver superior outcomes to consumers than monopolies is easy to understand when one understands the differences between a government-run monopoly situation and a corporate monopoly. The latter, arguably, are always worse for the consumer than competition. The former, however, need not be. Without the need to spend on market, the state-run monopoly can keep prices lower and/or plow earnings back into delivering higher service levels or a better product. The goods and services subject to government monopolies are typically ones where consumers are motivated by benefits beyond price -- the state run monopoly can focus specifically on those benefits without doing a cost-benefit analysis on them. This is not to say that a state-run monopoly is always going to outperform a competitive market. Certainly the market conditions will have an impact on whether the industry is suitable for government monopoly. Additionally, a poorly-run or greedy government monopoly that behaves like a corporation will deliver worse results than a competitive market. But that rule is not as universal as economic orthodoxy would have us believe.
Baily, M.; Gordon, R.; Bresnahan, T. (1993). Competition, regulation and efficiency in service industries. Brookings Papers on Economic Activity, Microeconomics. Vol. 1993 (2) 71-159.
Epple, K. & Schafer, R. (1996). The transition from monopoly to competition: The case of housing insurance in Baden-Wurttemberg. European Economic Review. Vol. 40 (1996) 1123-1131.
Felder, S. (1996). Fire insurance in Germany: A comparison of price-performance between state monopolies and competitive regions. European Economic Review. Vol. 40 (1996) 1133-1141.
Ungern, T. (1996). The limits…[continue]
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