In theory, the free market gives rise to consumer sovereignty; that is the freedom of individual consumers to decide what they want to buy. This in turn influences the decisions of suppliers through the working of the price mechanism. This presupposes that, although price is determined by the interaction of supply and demand, it is demand that is the dominant factor rather than supply.

A market failure reflects an imperfection in the market, whereby the power is shifted away from the consumer to the supplier. Thus supply becomes the dominant factor in determining price. This could occur for a number of reasons, but they all lead to one situation - an element of monopoly power, which in turn leads to higher prices.

The question that is being posed by this week's contribution is whether in Malta we have a situation of market failure in certain product areas. I am querying whether today we have a situation where certain suppliers are exercising an element of monopoly power, thereby pushing up the prices at which they sell their products or services and consequently their profit margins, at the expense of consumers.

What leads me to ask this question is the latest data on the consumer price index and the rate of inflation. One must bear in mind that it is often claimed that the economy is not performing well, that the purchasing power has gone down dramatically and that in general consumer confidence is at a very low ebb.

All this should lead to a situation where the market would push the price level downwards. In effect the opposite is happening. The data published by the National Statistics Office shows that for the months of May the annual change in consumer prices has risen to 3.45 per cent, while the annualised inflation rate stood at 2.92 per cent.

In May 2004, the annualised inflation rate stood at 1.95 per cent, while the annual increase in consumer prices was measured at 2.4 per cent. The inflation rate registered in May 2005 was the highest since September 2002. If the economy is not performing well, what could be happening to cause such an increase in consumer prices?

The table below gives an indication of the percentage increase in consumer prices by broad categories, as reflected in the Household Budgetary Survey.

Food 3.5%
Beverages and tobacco 1.7%
Clothing and footwear -0.2%
Housing 6.3%
Water, electricity, gas and fuels 18.4%
Household equipment and house maintenance cost 1.9%
Transport and communication 4.2%
Personal health and care 3.9%
Recreation and culture 0.9%
Other goods and services 3.2%

One should eliminate those categories that have experienced an increase in prices below the global average. Likewise the increase in the prices of water, electricity, gas and fuels is attributable to the measures announced in the last budget of an 18 per cent surcharge on the price of electricity, in the light of the increase in the international price of fuel and of an increase in the price of kerosene.

This leaves us with food that takes up nearly a quarter of our expenditure, housing that takes up just under eight per cent of our expenditure, transport and communication that represent also nearly a quarter of our expenditure, and personal health and care that take up just over six per cent of our expenditure.

The increase in the price of housing has now become worrying not just from an economic perspective but also from a social perspective. There is an evident attempt at speculation, which is leading to a bubble in housing prices. I believe that property developers had better seek to deflate the bubble themselves as they are running the risk of it bursting in their faces.

Housing is becoming unaffordable for several young couples seeking to buy their first home. Moreover, house prices are such that they are diverting resources away from other forms of expenditure to the extent that they are causing a distortion in the market.

The other group of products that had a price increase higher than the average was that grouped under the heading of transport and communication. Here we are talking of bus fares, telephone bills, postage, internet connectivity, satellite television connectivity and other forms of television services, air fares, etc. An element of the increase in prices is due to the increase n the price of fuel.

The two product categories that are a case of most concern are food and personal health and care (which includes pharmaceutical products). They are a cause for concern because it is probably in these two product categories that there may exist an element of market failure.

The question that needs to be posed is whether the Malta market is too small for it to allow more than two or three major players for any type of product. If this is so then it become fairly easy to shift the power in the determination of the market price from the consumer to the supplier.

This could also be happening because in certain respects, certain players in the market have verticalised their operation, such as for example importers becoming retailers. Worse still, service providers have become involved in the distribution of products against all norms of professional ethics. Could it be that the growth of retail outlets of a large size is being impeded in this country because otherwise they could become a threat to importers and distributors?

What are the options for the government? Previously the government would impose what was called a price order. We should certainly not be going back to those times. This mechanism also created an element of monopoly power and in its own way distorted the market.

What we need is for the market to function properly. This requires the government to make use of the various regulatory tools it has at its disposal to monitor developments and to take the steps that the law enables it to take. We also need strong consumers' associations that serve as a counterbalance to those parts of the business sector that are contributing to this market failure. Market failure is bad for the economy and the country as a whole.