Monday, August 30, 2010

Competition Series Part IV: The future

While competition can clearly bring significant consumer benefits (think Virgin Blue and the airline shake up, or Aldi and current supermarket competition) the evidence is clear that this is not always the case, and that harnessing the innovation stimulated by competition can come with a large coordination cost.

One major consideration as to whether competition can work effectively – will government still control a production bottleneck?

For example, once airport runways are operating at capacity, the government will have the final say on approving new runways. In the mean time, airport owners can act as a monopoly as there is a huge, in fact insurmountable, barrier to entry.

A second consideration is whether the private firms will be allowed to take all their risk.  In banking we have seen a bizarre situation where banks have been thrown a government lifeline with no obligations, and have since returned to record profits (read this article for a good discussion on reciprocal obligation of banks).

Further, competition reforms have also been more broadly focussed than the privatisation of various layers of vertically integrated monopolies.  Where this cannot be achieved, one outcome is that a regulatory authority ensures that a monopoly ‘acts in a competitive manner’ without actual competition, and the risks that competition exposes. This type of reform is the least effective – government sets prices that ensure returns commensurate with a hypothetical competitive firm, with associated levels of risk, yet there is in fact no risk taken.  If the monopolist undertakes ineffective investment, the regulator will set a price that ensures a profit is made anyway.  Indeed, the incentive under this arrangement is to increase costs, knowing that government set a price that recovers a return on any expenditure.  None of the supposed benefits of competition exist under this arrangement.  

Competition reform without actual competition fails.  The only possible saving grace could be if profits from government owned corporations were used to reduce tax burdens elsewhere in the economy (although it is a stretch to expect this type of efficient spending from government).

In the end, avoiding government incompetence and rent seeking from monopoly control comes at a cost, and it appears that the mixed economy is here to stay.  In the mixed economy, government monopolies can provide a base upon which private firms can compete.  Government already provides the democratic and legal base upon which private enterprise thrives.  Why not think of the provision of some monopoly services as an extension of basic government requirements?  I’ll leave the final word on this series to Professor John Quiggin.   

The case for public ownership is strongest where market failure problems are likely to be severe. In the case of infrastructure industries, several market failures are important. First, because of the equity premium and the associated problem of short-termism, private providers of infrastructure may not invest enough, or in a way that maximizes long-run benefits. Second, infrastructure facilities often generate positive externalities that are not reflected in the returns to the owners of those facilities. For example, good quality transport facilities will raise the value of land in the areas it serves. Finally, there are problems associated with the natural monopoly characteristics of many infrastructure services.

Conversely, the case for private provision is strongest where the efficient scale of operations is small enough to allow a number of firms to compete and where markets function well, rewarding firms that innovate to anticipate and meet consumer demand, and eliminating those that produce inefficiently or provide poor service. In particular, in sectors of the economy dominated by small and medium enterprises, where large corporations cannot compete successfully, it is unlikely that government business enterprises will do much better. My home state of Queensland provides historical support for this claim, having experimented, unsuccessfully, with state-owned butcher shops, hotels and cattle stations early in the 20th century.

There will always be a range of intermediate cases where no solution is obviously superior. Depending on historical contingencies or particular circumstances, different societies may choose between public provision (typically by a commercialized government business enterprise), private provision subject to regulation, or perhaps some intermediate between the two, such as a public-private partnership.

No comments:

Post a Comment