The Productivity Commission has released the final of its three technical reports into the superannuation industry ahead of the release of its final report next month. This paper, which according to deputy chair of the commission, Karen Chester, contained some of the “most complex modelling the commission has ever done,” looked at the question of economies of scale in the industry and found that merging smaller, high cost super funds with larger ones could save up to $1.8bn a year in costs and lead to an extra $22,000 on the average superannuation balance.

Economies of scale involves situations where firms are able to carry out operations better the bigger they get. It can occur to due cost savings – as it may cost less on average to administer one million accounts than it does 10,000 – or it may come from being able to make better investments because the size of your assets enables you to seek out investments with better returns, or enables a better diversification of the portfolio.

It is a significant issue in the superannuation system which has an abundance of small funds – many of which are high cost and underperforming.

The commission found over the decade from June 2006 to June 2016, the highest proportion of the superannuation firms that exited the system through mergers with bigger entities were in the smallest quarter:

They also found high costs were a major factor, as the average expenses as a proportion of assets was significantly higher for those small superannuation firms that left the system than for those that have remained:

But the report found while firms have over the past decade, for the most part, taken advantage of economies of scale the trickier thing to determine is how they have made use of them.

One thing they did find is there is scarce evidence firms have passed on the savings from economies of scale through lower fees.

This does not necessarily mean the firms are ripping us off, because there is some evidence industry super funds for example “may have passed through some scale economies in higher returns by investing more heavily in (higher-cost) unlisted assets and securing higher returns as a result”. But they also note the data is rather weak on this.

One area they are more confident on is while not-for-profit funds “do obtain higher net returns” the larger they get (on average) but rather oddly “no corresponding relationship exists for retail funds”.

This result is not so much because economies of scale do not exist for retail funds, but as the previous reports have shown, so poorly do retail funds perform, it doesn’t really matter how small or big they are – they’re all mostly bad.

The commission found the savings from increased mergers would be quite significant.

It found in “a scenario where mergers occurred between the 50 highest cost and 10 lowest cost funds (regardless of fund type)” the annual savings “are estimated to be at least $1.8bn (with 50% probability)”

The commission found “if the median cost saving from these gains was passed through to all members as lower fees then holding all other costs constant an average member within the system would be $22,000 better off in retirement”.

Of course the more high-cost funds merged with low cost ones, the greater the benefits. The commission estimates with a 70% probability the annual savings of the 100 highest cost firms merging with the 10 lowest would be $2.4bn.

In some ways this report is a bit economic-nerdy compared to the previous two reports, which looked at performance of funds and the impact on the economy of the superannuation system. But the paper fits as a nice conclusion to the three papers which have sought to evaluate and highlight deficiencies in the system and ways in which superannuation holders would get more of what they want – lower fees and better returns.

One major finding of its research has been there are too many poor performing funds in the system which have not been merged with other larger firms because of a lack of real competition in the system and also a weakness on the part of the finance regulator Australian Prudential Regulation Authority (Apra) to encourage or even force their merger.

As the PC found in previous reports the costs of being in an underperforming fund compared to one in the top 10 are significant – worth around $375,000 to your superannuation balance.

So while the extra $22,000 from the improved economies of scale might seem small beer, combined with an associated removal of high-fee charging dud firms as a result of the mergers, overall superannuants will be much better off:

When the final report from the productivity commission is released next month the recommendations will be based on some of the most detailed and innovative economics work undertaken in recent times. It has seen the commission do its best to swim in politically treacherous waters and has done so by being fund type agnostic. Instead it focussed on the holders of superannuation and asked what is best for them.

The report will likely recommend a reduction in funds, policies such as a best of list from which new entrants into the work-forces can choose, and it will again highlight the damning evidence of the under-performance of the retail sector, and also even some not-for-profits funds would be better off merging.

All of these aspects will be unlikely to be taken up by a government seemingly in its death throes, and which thus far has been unwilling to do little to alter its desire in the face of overwhelming evidence to protect the retail sector.

It would be a shame however if this excellent work by the commission is stuck on the shelf – and should the ALP win election next year, in spite of some push-back from the industry super sector, it should very much take on board the findings of this inquiry.