Competition: No Solution to Israel’s High Cost of Living After All

Kahlon was wrong: Now Israel has too many cellphone companies. In Israel's tiny economy, competition isn't always going to work.

Tomer Appelbaum

May 14, 2012 will go down in the annals of Israeli consumer history as one of the few times the little guy won against big business. That was the day that the cellphone revolution began.

By removing impossibly high entry barriers, despite the howls of the incumbent companies, Communications Minister Moshe Kahlon paved the way for upstart new mobile operators that charged a fraction of the price for service. And the people cheered.

Israelis were thrilled: not only did they save billions of shekels in the three years since. They also have the pleasure of getting monthly bills without complicated and unfathomable charges. They are spared runarounds from so-called service centers, and the frustration of knowing that Cellcom was Tweedledum and Partner and Tweedledee and Pelephone was Tweedledoo, different names and logos but basically the same deal.

Before that C-Day three years ago, there was no escaping the clutches of the cellphone cartel.

The cellular reform made Kahlon a hero for reformists and propelled him into the finance minister’s chair, where great things are expected of him in shaking up the housing market and the banking sector.

Netanyahu may have scored by scaring voters into thinking the Arabs were poised to take over the country. But Kahlon got mandates from people who were still savoring the great day they told Partner/Cellphone/Pelephone to take their monthly plan and perform an indecent act with it. Forget the politics of fear, there’s a future for the politics of glee.

Miracle cures and band-aids

Kahlon not only made political hay out of the cellphone revolution, he proved – or so it was thought  –  that the cure for a lot of Israel’s economic ills is to take down the cartels, like the cellular one, and replace them with unrestrained free markets.

The list of sectors in the antitrust eye is a long one and includes many of Israel’s most hated industries – the banks, the supermarkets, natural gas, property, electric power and aviation, to name the big ones.

Yet three years later, the panacea of competition so extolled by economists and the media looks more like a band-aid than a miracle cure.  

Consumers are enjoying the low rates and clarity, but the mobile operators are hurting. The veteran Cellular Big Three slashed overheads, and debt, to survive but their revenues shrank 15% over the past three years, their profits are a fraction of the past and two of the companies predict losses in the third quarter of this year.

It’s hard to shed too many tears for cellphone companies, but consumers have good reason to worry that the situation wrought by the come-hell-and-high water competition in the industry is unsustainable

Magen David Adom

And thus the revolution ends

The first signs appeared in the last couple of months with two low-cost upstarts, YouPhone and Home Phone, merging into bigger rivals. Last week, Golan Telecom announced it also wanted to be acquired or merge and a day later, Cellcom said it was interested. Surging share prices for cellphone stocks in recent weeks suggests that the stock market feels the era of competition as we briefly knew it is over.

On the surface of things, it looks like it’s back to business as usual in Israel. The cartels, the tycoons and special interests are going to win again; competition, and the lower prices and better products and services it brings, is going to be sacrificed for the benefit of the plutocrats. 

But it’s not that simple.

Israel is a small economy and an isolated one, in the sense that we don’t have porous borders with our immediate neighbors that would allow goods and services to flow easily between countries, as is the case in Europe. The whole market is one of eight million people, which is tiny by global standards.  Dividing up a market that tiny among a multitude of rivals means economies-of-scale disappear, costs rise, and prices follow.

Moreover, the problem of cartels is so pervasive in Israel that whatever savings might be achieved by imposing competition on one sector will be undermined by the lack of competition in another.

For instance, improving competition in the supermarket sector – a favorite target for trustbusters – assumes that there is competition in food manufacturing and importing, and that real estate is available for new stores to open to go ahead-to-head with existing ones. But these conditions do not exist, and what we have in the Israeli supermarkets scene is a cellphone situation. Prices for consumers have dropped, but so have the companies' revenues and profits. As competition arose in the form of spreading heavy-discount stores, Israel's second-biggest supermarket chain, Mega, has effectively imploded, selling stores and firing hundreds of employees.

Like with cellphone operators, there’s a limit to how many supermarket chains Israel chains can compete successfully in wee Israel. If competition is let loose, eventually some will fall.

Rami Levy, the upstart who introduced heavy-discount shopping to Israel, thrives but Mega is struggling and may die. Mobile upstart Golan Telecom is reportedly making an operating profit, but that’s only because it hasn’t erected its own network, as it would have to do soon under the rules. The realization that time is running out is what drove Golan into seeking a merger or sale.

Risky banking business

Competition in banking is even more problematic. More competition created by increasing the number of players, i.e., smaller ones, not only makes them less efficient but less financially sound. Competition in financial services may lead to lower fees but more often it leads to excessive and risky lending. It’s no wonder the Bank of Israel isn't beating the drum of competition in the banking sector.

The solution for Israel isn’t always more competition. In many cases more regulation and in many cases, price controls. Regulation and controls are very much out of favor, which is understandable given the government’s poor record in employing either tool.  But, given the situation, they may be our only choice.