Tuesday, November 20, 2007

BHP and Rio

Reading about BHP's 'friendly' bid for Rio (don't you hate it when your friends aren't returning calls?) gives one pause for thought. The undercurrent of commentary in the Australian media is that a merger would presage ongoing export growth in the commodities sector and hence be good for Australia. A merged BHP and Rio would exploit synergies to increase production and move product more efficiently into the hands of buyers. And a merged BHP and Rio would be able to exploit its market power in the negotiation of commodity prices - especially iron ore - with China and other growth economies. This is where a note of caution must be sounded. In recent history, a high iron ore price has been a net positive for the Australian economy, and a strong positive at that. Greater prices mean that marginal projects will be funded, non-marginal projects are more profitable, exploration becomes economic, employment grows and even government coffers are filled with increased corporate and personal tax receipts. However, whereas a high iron ore price is generally good news for Australia when it results from the natural order of things - the workings out of supply and demand in relatively decentralised markets - the same may not be true when higher prices are a function of a BHP-Rio monopoly. In all monopolies, the most profitable thing to do tends to be to underproduce to some degree while maintaining a higher price than would be achievable in a more competitive market. So it might be that a merged BHP and Rio would hold back production to a greater degree once merged. This would lead to lower investment in the Australian commodities sector, lower employment and a net negative effect on the Australian economy. So a high iron ore price, while good for Australia right now, is not an unequivocal benefit and is not something that we should necessarily view as a positive coming out of a BHP-Rio merger.

More food for thought: would a merged BHP-Rio have monopsony power in the acquisition of labour in the commodities sector?


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