Public Policy towards Private Enterprise

Industrial Economics

Objectives

• The aims of competition policy– Per Se v The rule of reason– Resource misallocation v Consumer Welfare

• State intervention– Private v State ownership– Regulating markets– Industrial Policy (being proactive and not reactive)

• The Colonna report• The future!

How the per se process should work.

Does the restraint have efficiency creating potential?

Are the markets shares of the firms involved large enough to make the restriction of output profitable?

The action is illegal

Yes

Yes

Resource misallocation v Consumer Welfare

One issue is whether antitrust policy should minimise the

resource misallocation effects of market power (which is the deadweight loss)

or should antitrust policy minimise consumer injury

from the exercise of market power (which is the deadweight loss and the transfer of income from consumers to producers).

Resource misallocation

Quantity

Price

Demand

Marginal cost

QcQm

Pc

Pm

Spending shift

to other industries

Income transfer

to monopolist

Deadweight

welfare loss

What is Privatisation?

• Privatisation refers to the processes by which assets or activities owned and controlled by the public sector are subjected to market forces.

These include the closure of plants in ‘sunset’ industries; the competitive tendering for activities once carried out solely

by public service organisations; the deregulation of markets; and the transfer of assets to the private sector by share flotation or

private sale.

(*) Public utilities includes electricity, gas and water supplySource: OECD, Financial Market Trends

Rationale for state ownership of PublicUtilities

• social ownership of production

• allow economic planning of key sectors

• distribute income

• positive externalities

• create a less adversarial industrial relations environment

• the existence of Natural monopoly.

Rationale against state ownership of natural monopolies

Public Choice Theory

Govt employees motivated by self interest and not the public interest.

Politicians shape policies to maximise votes, justifying any kind of policy as in the public interest; even though this may involve considerable tax burdens.

Rationale against state ownership of natural monopolies

Property Rights Theory

There is no direct interest in the yield from state assets because there are no shareholders (i.e. owners with property rights).

Management is less constrained in nationalised industries. Poor management will not depress the capitalised value of the enterprise and tend not to be visible.

Arguments for privatisation

• Increased competition

• increased discipline of capital markets

• reductions in government borrowing

• reductions in government control

Issues resulting

• sunk costs due to networks which led to some networks having to be separated from service providers.

• in some areas, e.g. energy, competition has been slow in coming.

• Use of Chadwick-Demsetz auctions. e.g. railway routes

Regulating the market

Time

Intensity of

regulation

Phase 1:Monopoly

Phase 2: Monopoly and Competition

Phase 3:Competition

Regulationfocuses on theprevention ofmonopolyabuse indownstreammarkets

Competition gradually introduced, regulation deals with retail and access prices, emerging competition issues and public service

obligations.

Light-handed regulationneeded to ensure fair trading practices and themaintenance of publicservice obligations

Regulating the market

UK regulators have practised the RPI-X scheme (with variations depending on the industry) where RPI refers to the retail price index and x is a cost efficiency factor determined by the regulator.

X is determined by•the costs and structure of the firms asset base•expected efficiency gains through enhanced productivity•future demand expectations•future investment plans•the expected impact of the regulation on competition

Why do governments intervene?

• Market failure– externalities– large sunk costs– increasing returns to scale– information imperfection

• Paternalist intervention

• Transaction costs

Types of industrial policy

• Passive and negative– regulation of dominant positions & monopolies

• Passive but positive– regulation of dominant positions & monopolies– fiscal, financial and legal measures to aid

competition– deregulation

Types of industrial policy

• Active but negative– sectoral and defensive trade policies to curb

threats from emerging economies

• Active and positive– co-ordination of national economic policies– the state acts as a supplier of capital– ‘picking the winner’ policy

Types of industrial policy

• Active, positive and directly involved– the state acts as an entrepreneur and innovator

Types of industrial policyanother way of classifying

• A minimalist approach

• The favourable economic environment approach

• The active, negative sectoral policy approach

• The active co-ordinator approach

• Direct involvement in production.

The Colonna Report (1970)

• Creation of a single market.

• Harmonisation of company & banking laws and taxation.

• Promotion of trans-community mergers.

• Promote new technology.

• Integrate social and regional policies.

• Develop a community commercial policy with 3rd countries.

A future European industrial policy?

• Completion of a favourable European business environment.

• Building up of European filières, clusters and business districts.

• Building up of Euro-champions.• Provide the finance to develop a European

system of innovation.• A concerted policy vis-à-vis third countries.