4.1.8.8 - Public ownership, privatisation, regulation and deregulation of markets

Public Ownership =

State control of firms, industries or other assets

Nationalisation =

The transfer of assets from the private sector to public ownership

Examples of Nationalisation in UK

• Network Rail in 2014

• Bank of England in 1946

Arguments FOR Public Ownership / Nationalisation

Ability to Control Natural Monopolies

• Natural monopoly is when the most efficient number of firms in an industry is one because of high entry costs meaning always achieving EOS

• Therefore, if no nationalisation and controlled by private sector, it would create a private monopoly which might seek to set higher prices which exploit consumers → reduced allocative efficiency

• Therefore, better to nationalise to have a public monopoly

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Maximise Social Welfare

• Gov will focus more on maximising social welfare rather than just maximising profits for shareholders. Can therefore:

  • Minimise negative externalities in production

  • Provide non-profit goods/services

  • Provide socially optimum level of g&s

  • Ensure prices are low and fair for consumers

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Greater Control of Economy

• Control of key strategic industries (coal, steel, rail, utilities) can be seen as best way to control an unstable market economy

• Also, a single integrated system run by gov may be more efficient than multiple businesses operating simultaneously (e.g. one rail network, one road system)

Arguments AGAINST Public Ownership / Nationalisation

X-Inefficieny & Lack of Dynamic Efficiency:

• Lack of competitive pressure & subsidies from gov leads to:

  • Organisational slack & average costs rise → X-inefficiency

  • Less pressure on managers to drive down unit costs → ↓Productive efficiency

  • Less incentive to reinvest in innovation & R&D + Less supernormal profit → ↓Dynamic efficiency

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Lack of Expertise:

• Often better managers & leaders are found in the private sector where the financial rewards are greater

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Worsen Gov Finance:

• Gov responsible for funding all the required costs of the industry → Large opportunity cost

• Funding all capital investment

• + Gov will not collect any corporation tax revenue

Privatisation =

Sale of government owned (public owned) assets to the private sector

Examples of Privatisation in UK

• Royal Mail in 2013

• British Gas in 1986

• British Airways in 1987

Arguments FOR Privatisation

Monopoly vs PC diagram

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Increased Competition Improves Efficiency

• Competition & profit motive → firms incentivised to cut average costs → ↑Productive efficiency

• To be competitive and survive, must cut unnecessary costs → ↓X-inefficiency

• ↑Price competition → firms undercut each other’s prices → Lower prices → ↑Allocative efficiency

• ↑Supernormal profits → ↑Dynamic efficiency

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Improves Gov Finances

• In SR, Sale of assets increases revenue

• In LR, reducues public spending & borrowing + increases corporation tax rev

Arguments AGAINST Privatisation

Cannot Control Natural Monopolies

• Natural monopoly is when the most efficient number of firms in an industry is one because of high entry costs meaning always achieving EOS

• Therefore, if privatisation, it could create a private monopoly which might seek to set higher prices which exploit consumers → reduced allocative efficiency

• If do attempt to split natural monopoly when privatising, loss of a lot of economies of scale → Less productive efficient

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Loss of Social Welfare

• Private firms focus on profit maximising rather than improving social welfare. Could lead to:

  • Increased negative externalities in production

  • Under-provide merit goods

  • High and unfair prices for consumers → ↓Allocative efficiency

Evaluating Privatisation (IDO’s)

• The type of industry - industries that produce public goods should not be privatised as introducing profit motive does not make sense

• Effectiveness of regulators - Need regulators to prevent abuse of monopoly power

• Degree of contestability or competition - If low barriers to entry, competition likely to be healthy

Regulation =

Setting rules and controls that restrict market freedom

Example of Regulation in UK

2012 Financial Services Act in response to GFC, introduced the FCA, PRA & FPC to regulate financial services.

Arguments FOR Regulation

Allocative Efficiency

• Max prices → ↑allocative efficinecy

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Reduces Monopoly Power

• Block mergers, break up monopolies

• Max prices to limit monopoly profits

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Health & Safety at work

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Price Discrimination & Consumer Rights

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Reduces Neg Externalities

Arguments AGAINST Regulation

Reduces possible benefits of Monopolies:

• Reducing supernormal profits may eliminate R&D opportunities → ↓Dynamic efficiency

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Costly:

• Regulation requires lengthy investigations → large cost to taxpayers

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Risk of Gov Failure:

• Regulatory capture - regulatory agencies, meant to protect the public, instead promote the commercial interests of the industry they regulate → makes misallocation of resources worse

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Free market argument:

• Process of creative destruction will remove monopoly power in LR

Regulatory Capture =

A form of government failure where regulatory agencies, meant to protect the public, instead promote the commercial interests of the industry they regulate.

• i.e. operating in favour of producers rather than consumers

Deregulation =

Removal of rules and controls that restrict market freedom in order to increase the efficiency of markets

• Supply-side policy which removes barriers to entry

Deregulation Chain of Analysis

• Deregulation is the removal of rules & controls that restrict market freedom.

• This is a supply-side policy, which removes barriers to entry and thus facilitates contestability

• This should increase both actual & potential competition

• As a result, monopoly firms convert to monopolistic competition

• Therefore, in LR, supernormal profits are eroded away.

• Market price should become lower, closer to that of allocative efficiency

Example of Deregulation in UK

‘Big Bang’ - Deregulation of financial markets

Arguments FOR Deregulation

Increased competition:

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Productive Efficiency

• ↑Competition → ↑Price competition → Firms need to minimise costs so they can offer similar prices → ↑Productive efficiency

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Reduce X-Inefficiency:

• ↑Competition → Firms have to reduce unnecessary costs and cut organisational slack to survive → Reduces X-Inefficiency

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Allocative Efficiency:

• ↑Competition → Price competition - firms undercut each other’s prices → Price falls closer to P=MC → More allocatively efficient

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Improves consumer choice:

• More alternative firms to buy from

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Increased contestability:

• Firms reduce prices due to threat of competition

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No risk of regulatory capture

Arguments AGAINST Deregulation

Reduces possible benefits of Monopolies:

• Reducing supernormal profits may eliminate R&D opportunities → ↓Dynamic efficiency

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‎Price Discrimination & Consumer Rights

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Neg Externalities