Leslie Budd on... risk

Video

Audio

Text

Businesses are competitive but often don’t like competition because price wars can lead to a zero sum gain. Similarly, businesses bemoan regulation and cite trivial examples to support their case, yet regulation sustains their competitive environment. The outcomes of these paradoxes have been amply demonstrated by recent events, and the incentives for firms to cooperate and supposedly collude. In industries dominated by large firms rumours abound of secret annual meetings in which prices are set. What connects all these things is risk.

There are many types of risk but I wish to concentrate on two; systemic risk and regularity risk. Systemic risk occurs when there is a threat to the economy or the financial system as a whole. Regularity risk occurs when new laws and regulations challenge business activity.

Let’s look at this example, or an example in practice. The world’s three largest iron ore producers are currently negotiating their annual price contracts with their customers. One of them has proposed an 80% increase for European steel makers and 100% for Chinese ones. The others have not yet set out their stall, but if this price increase becomes the norm then there is a danger of systemic risk increases as European steel makers migrate or go bust.

Consequently, there may be regularity risk for the iron ore producers in that their customers may seek government intervention to combat the monopoly power of this global triumphant. In this context the bottom line is that if you cooperate just in the interests of your industry short-term increases in economic rents may lead to the zero sum gain of less wealth creation in economies and markets elsewhere.

That’s my view, you can join the debate with the Open University.