8-What Do We Really Believe?

Government regulation of prices allows customers to enjoy lower prices… In theory. In practice, regulation increases supplier costs and reduces supply, even in the face of increasing demand. Over the long-term, prices either meet supplier costs or suppliers withdraw. In any case, customers as a group face more limited choice. Here is the story of two government initiatives to reduce prices for consumers.

Posted 3/31/08

There were two items of interest in recent press reports. Both suggest something about our fundamental beliefs in our economic system.

The first instance occurred in California. The State Insurance Commissioner asked Allstate to reduce its automobile rates in the state by nearly 16%. Allstate insures about 10% of California automobiles. The owners of these automobiles will save about $124 per car. The reductions came because the state concluded that the companies were charging too much for their services.

In a separate event, the State of Arkansas ordered sixty companies who offer payday-lending services to close down immediately. These payday lenders advance money to a borrower to bridge the period between paydays. The lenders charge a fee, plus interest. The State of Arkansas concluded that this service violated a constitutional requirement that bars lenders from charging an annual interest rate higher than 17%.

Both of these stories are examples of a lack of belief in the effectiveness of a capitalist system. There is no indication in either case that new entrants are barred from entering the market. If the automobile insurance companies charge too much, their profits will be unusually high. New companies will enter the California market with a promise of lower prices to attract their customer sales volume. The same would hold true with payday lenders in Arkansas. If California and Arkansas believed in the effectiveness of capitalism, they would simply wait until the new entrants reduced the prices in the state. They apparently do not believe that capitalism works.

***

Update 2021

The automobile insurance industry in California is led by State Farm with 13.7% market share. Allstate is now fourth with a 9% share.  Several of the larger firms in the California 2020 casualty market are failing in Reliability by refusing to renew insurance plans with customers in areas they regarded as having a high fire danger. This will, undoubtedly, cause more market share change in the California market.

Payday loans were widely available in Arkansas, with term limits of 31 days, loan limits of $400 and price limits of 10% of loan with fee limit of $10.  While regulators pressure payday lenders, the fees on more traditional bank loans impose a heavy burden on small borrowers who might have used payday lenders.

Regulators’ concerns in both of these markets were that customers were being gouged, taken advantage of, by greedy companies. What these regulators did not consider is that, in an open market, pricing power eventually shifts from a company to the customer. See HERE for how this happens.

***

Update 9/25

The regulation of these two markets has taken them in dramatically different directions. California has ample policies available, but prices are high. Over the last couple of years, California has suffered from the withdrawal of some important homeowners insurance companies. New policies for homeowners insurance are difficult to come by and expensive.  In some cases, they are not available at all. This industry pulled back from the homeowners market has had some limited effect on the California automobile insurance market. Many customers who bundled their insurance coverages with one company have had to shop around for a new supplier if they were insured by one of the companies withdrawing from the homeowners insurance market. Automobile insurance prices have firmed. Pricing in the automobile insurance market has risen considerably faster than inflation and also faster than increases in the national market. Some of this increase is due to a doubling of minimum insurance coverage requirements for California drivers. Pricing seems to be sufficient to keep good insurance companies in the automobile market. It is likely that California regulators do not want to see the same insurance company withdrawals from the automobile market that they have witnessed in the homeowners market. Pricing is not under government pressure today.

The payday lending industry has had a significantly different outcome the last 10 years. The industry has come under intense regulatory pressure. Total volumes in the industry are less than 40% of what they were 10 years ago as governments have imposed onerous price caps and other restrictions. Some of the business has shifted online, but overall volumes for the industry are in decline. As a result, the industry is consolidating around several major companies where once there were hundreds of competitors. The State of Arkansas has been particularly difficult on the payday lending industry. The state effectively banned these lenders by setting uneconomic price and term restrictions. The industry has fled the state and has not tried to reenter. Where once there were 275 payday lenders in the state, there is no single survivor. The erstwhile customers for this industry in Arkansas must look elsewhere for a short-term borrowing solution. Are they better off?

***

 

THE SOURCES OF STRATEGYSTREET.COM: For over 30 years we observed the evolution of more than 100 industries, many hostile.  We put their facts into frameworks applicable to all industries and found patterns.  Strategystreet.com describes the inductive results of these thousands of observations and their patterns.