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Assignment 3

Economia del Sector Público (Universitat de Barcelona)

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DOCUMENT: Chapter 3 ook Glo alizatio a d its dis o te ts. Freedo to hoose
Privatization
In this part of the chapter 3, the author makes an approach to the issue of
privatization. Although Stiglitz recognizes in some parts that privatizations can rapport
some benefits to a country it mostly talks about the bad prejudice it can cause to
societies.
One of the things it says is that some organizations like the IMF prefer privatizations to
be done fast rather than slow but well planned. In part that is because this
organization mainly focuses on the macro data of a country and not in the structural
problems that a fast gain of money by a privatization can lead. Another of the reasons
for which the IMF thinks that privatizing fast is a good option is the fact that they think
that this gap that appears in the market is going to be covered very fast. But as the
author points out with the example of Morocco sometimes is not the case because
sometimes the state maintains a company that just have losses because of the social
benefit that it produces while when it is privatized as there are just losses they prefer
to shut down.
Another critic to privatization in the text is that sometimes when a company is
privatized and its new owner is from the same country they are more willing to keep
the same work force trying not to fire out many people while if it is owned by a
foreigner that just have an obligation with the shareholders they will be more willing
to fire people in order to turn the company the more efficient as possible.
Privatizing companies can create monopolies and that can cause a great prejudice on
societies because they can charge mainly the price that they want for a service, as is
the ase of Côte d I oire a d the o u i atio s.
Another big problem that can arise from privatizations is that they can lead to a
situation in which the company is given to a friend or the new owner is selected
according to the bribe they give. That can open a space for corruption and bad
administration of these new companies that affects the whole society of the country.
This is the case of Russia.
The author basically says that in the process of a privatization lots of factors have to be
take i to a ou t like the pro ess follo ed, the ki d of o pa … a d keepi g i

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Pol Gonzalez Feliu Group A6 Public Sector Economy

mind those factors try to make the best choices for the societies and not just for a little
group of people.
Liberalization
Li eralizatio o urs he the go er e t s i ter e tio i trade or the arket gets
reduced until it disappears.
The text talks about how trade liberalization has different effects according to the
countries. It says that the liberalization of the trade market have to be done slowly. If it
is done fast then a lot of jobs are destructed without time to create new ones. That has
been a great problem for a los of countries that following the measures of the IMF
have tried to make a fast liberalization of their trade market what have made them
orse off, e ause the ere t prepared. A e a ple of a ou tr that has do e the
liberalization of its trade market at a good speed is China.
Another problem that nowadays occur with liberalization is that developed countries,
when sign treaties of commerce with developing countries, have a lot of exigencies but
without giving nothing in exchange.
The text gives us an example with the United States. The United States use to press
developing countries to lower their barriers for the American exported products, but
when the developing country would need the US to lower its barriers in agricultural
produ ts, it does t do so. Ne er the less, the US a d Europe keep o gi i g fi a ial
aid to its farmers and to create protectionism measures.
So this is kind of an asymmetrical relation that betters off the countries that are
already developed but worse off the countries that are still getting developed.
Another big issue is the financial market liberalization process, the IMF defends the
liberalization of this market because it says that free markets are more efficient and
this efficiency allows a greater economic growth.
But again this helps developed countries and worsens developing ones. It is said that
the financial crisis could have been caused by this liberalization of the financial market,
and while the developed countries could stand this heat in their economies again the
ones that had the worst were the countries that were still getting developed.
A statement that was made in favour of liberalization is that it promotes stability while
due to this asymmetrical relations that always occur between developed and

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de elopi g ou tries, for de elopi g ou tries li eralizatio does t ri g sta ility at

all.

DOCUMENT: Review of economic theories of regulation - Johan den Hertog

1. Interventions are made by the government due to market failures. This
regulation it should increase the social welfare. The public intervention has a
cost and the higher the degree of intervention is the major cost the
government will have to cover. These measures are meant to stabilize the
market and fulfilling the demand and the supply of all values.
2. Private interest theories stand for the thought that wealth has to be distributed
in an efficient way and to the efficient ones. These theories were developed to
explain the findings of ineffectiveness and inefficiencies of regulatory practices.
3. Some interest groups can be consumer groups, firms, regulators legislators,
unions and etcetera.
4. Because these are basic needs and speculation cannot have a big paper on it
although a huge amount of money is moved by this sectors and this is why
sometimes governments own this large companies, to ensure that no
speculations and huge benefit strategies are applied on them.
5. Because at the first moment the telecommunication network needed a huge
investment that only a government could face and it did, like in the Spanish
case. With time more companies get into the market and then they can have a
competition by their own.
6. The most accurate definition of regulation that we can find in the text ensures
that regulatio ill e take to ea the e plo e t of legal instruments for
the implementation of social-economic policy objectives. A characteristic of
legal instruments is that individuals or organizations can be compelled by
go er e t to o pl ith pres ri ed eha iour u der pe alt of sa tio s.
7. It has relation with the market structure and will be used to control prices, the
requirement to provide and all demand, labelling of the product, rules against
advertisement and minimum quality standard.
8. Conduct regulation is used to regulate the behavior of producers and
consumers in the market. Examples are price controls, the requirement to

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Pol Gonzalez Feliu Group A6 Public Sector Economy

provide in all demand, the labeling of products, rules against advertising and
minimum quality standards.
9. Social regulation comprises regulation in the area of the environment,
occupational health and safety, consumer protection and labor (equal
opportunities and so on). Instruments applied here include regulations dealing
with the discharge of environmentally harmful substances, safety regulations in
factories and workplaces, the obligation to include information on the
packaging of goods or on labels, the prohibition of the supply of certain goods
or services unless in the possession of a permit and banning discrimination on
race, skin color, religion, sex, or nationality in the recruitment of personnel.
10. Economic regulation is mainly exercised on so-called natural monopolies and
market structures with imperfect or excessive competition. The aim is to
counter the negative welfare effects of dominant firm behavior and to stabilize
market processes.
11. In this article, regulation is taken to mean the employment of legal instruments
for the implementation of social-economic policy objectives. A distinction is
often made between legislation and regulation. Usually in legislation regulatory
powers are allocated to lower level institutions or officials. The result of the use
of that power by these officials or institutions is then called regulation. Within
the perspective of some explanatory theories, the distinction between
regulation and legislation does not always add much additional explanatory or
predictive value to regulatory theories.
12. The services provided by the sectors are often essential for both businesses and
consumers. Interruption in the supply of these services will put a halt to
economic activities, bring a stop to interactions taking place in society at large
and these interruptions may thus present risks to life and health.
13. Because it assumed that theoretically efficient institutions could be seen to
efficiently replace or correct inefficient real world institutions. And this criticism
led to the development of a more serious public interest theory of regulation
hat has ee ariousl referred to as the Ne Ha e or Progressi e
S hool of La a d E o o i s.

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14. In the earlier development of public interest theories of regulation was

assumed that a market failure was a sufficient condition to explain government
regulation, and transaction costs and information costs of regulation were
assumed to be zero, but public interest theories of regulation take into account
theses costs, and it could be argued that government regulation is
comparatively the more efficient institution to deal with a number of market
failures.
15. Because with respect to the public utilities it could argued that the transaction
cost of government regulation to establish fair prices and a fair rate of return
are lower than the cost of unrestricted competition.
16. The more a regulator intervenes in the private operation of the firm, the higher
the intervention costs will be (curve IC). The regulator must have information
on cost and demand facing the firm before efficient prices can be determined.
There will be compliance cost for the firm in terms of time, effort and
resources. It will have to comply with procedures, adapt its administration and
incur productivity losses.
17. The regulator knows that increasing levels of intervention or standard setting
will increase costs (curve IC). The more detailed and precise, the higher the
regulatory costs. The higher the weight standard, the higher also compliance
costs will be: more nurses in the hospital and increasing use of capital
equipment in the construction sector. Indirect costs will also increase with the
level of intervention.
18. The assumptions over public interest theories rely are the prevalence of a
market failure, the assumption of a benevolent regulator or an efficient
political process and the choice of efficient regulatory institutions.
19. Anti-monopoly legislation is aimed at maintaining the efficient market
operation through merger control and by prohibiting anticompetitive
agreements or behavior.
20. The market demand curve D or average revenue (AR) intersects with the
declining part of the average cost curve of the firm, which implies that average
cost are minimized if the production is concentrated in one firm. If several
companies with the same production technology produce the same total

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quantity, the unit costs of production rise. For this reason, this situation is
called a natural monopoly.
21. Prices are set equal to average costs by means of rate of return regulation and
a price structure is determined such that the firm breaks even. Ideally, the
optimal price would of course be a price according to marginal resource cost.
This however, would lead to financial losses, depicted by the difference
between Pmc and ACopt. At Qopt the cost per unit is ACopt, while the revenues
per unit are only Pmc, which in the diagram is about 30% too low to cover
costs. The regulator thus has to choose between the inefficiencies of subsidies
or a pri e that o ers ost, ut that is ot first est effi ie t.
22. Public interest theories usually assume that regulation aims to establish
economic efficiency. Interpreted in this way, these theories are unable to
explain why on occasion other objectives such as procedural fairness or
redistribution are aimed for at the expense of economic efficiency (Joskow and
Noll, 1981, p. 36). On the other hand, when it is assumed that regulation
pursues social efficiency, another problem is encountered. Where there is
conflict between efficiency and equity, it is impossible for at least two reasons
to establish the social efficiency of regulation (Sen, 1979a, 1979b). Such
conflicts may arise when regulators mandate for example universal service
obligations for public utilities, cross-subsidies for certain consumer groups, the
prohibition to use price discrimination, minimum wage legislation or rent
control, and more generally the protection of disadvantaged groups. Firstly, in
such situations the evaluation of social efficiency is difficult because evaluation
standards of levels or dimensions of justice are not available. No agreement
exists regarding the 21 definition of justice in concrete situations (Dworkin,
1981). Secondly, the establishment of social efficiency of regulation requires
that economic efficiency and justice be weighed against each other.
DOCUMENT: The theory of economic regulation – Stigler
1. The central tasks of the theory of economic regulation are to explain who will
receive the benefits of burdens of regulation, what orm regulation will take,
and the effects of regulation upon the allocation of resources.

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2. A central thesis of this paper is that, as a rule, regulation is acquired by the

industry and is designed and operated primarfor its benefit.
3. Two main alternative views of the regulation of idustry are widely held. The
first is that regulation is instituted primarily for the protection and Benedit of
the public at large or some large subclass of the public. In this view, the
regulations which injure the public-as when the oil import quotes increase the
costo f petroleum products to America by $5 bilion or more a year- are costs os
some social goal (here, nacional defense) or, ocasionally, preversions of the
regulatory philosophy. The seocnd view is essentially that the political process
defies racional explanation: ``politics´´is an imponderable, a constantly and
unpredictably shifting mixture off orces of the most diverse nature,
comprehending acts of great moral virtue (the emancipation of slaves) ando f
th most vulgar veality (the congressman feathering his own nest).

4. The protection of the public theory of regulation must say that the choice of
import quotas is didacted by the concern of the federal government for an
adequate domestic supply of petroleum in the event of war- a remark
calculated to elicit uproarious laughter at the Petroleum Club. Such laughter
aside, if national defense were the goal of the quotas, a tariff would be a more
economical instrument of policy; it would retain the profits of exlusion for the
treasury. The non-rational view would explain the policy by the inability of
consumers to measure the cost to them to of the import quotas, and hence
their willingness to pay $5 billion in higher prices rather than $2,5 billion in cash
that would be equally attractive to the industry.
5. The most obvious contribution that a group may seek of the government is a
direct subsidy of money. The second major public resource Commonly sought
by an industry is control over entry by new rivals. A third general set of powers
of the state that will be sought by the industry are those which affect
substitutes and complements. The fourth class of public policies sought by an
industry is directed to price-fixing.
6. By the early 1930´s all states regulated the dimensions and weight of trucks.
The weight limitations were a much more pervasive control over trucking than

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Pol Gonzalez Feliu Group A6 Public Sector Economy

the licensing of common carriers because even the trucks exempt from entry
regulation are subject to the limitations on dimensions and capacity. We have
two measures of weight limits on trucks, one for 4-wheel trucks (X1) and one
for 6-wheel trucks (X2). We may then calculate two equations: X1(or X2) =
a+bX3+cX4+dX5, (where: X3= trucks per 1000 agricultural labor force, 1930;
X4= average length of railroad haul of freight traffic, 1930; X5= percentage of
state roads with high-quality surface, 1930).

Section 2

PRICE CAP REGULATION:

Pros:

a) Price Cap Regulation gives firms strong incentives to reduce costs and improve
efficiency while at the same time removing the negative incentives and inflate costs
associated with rate of return regulation.
b) Most price cap regulation formulae are applied for between three and five
years, any reduction in costs allows the regulated firm to receive a higher profit
in the interim. This provides incentives for the firm to cut costs since this can
flow through directly into profit.
c) While rate of return regulation is based on the firm's actual costs, price cap
regulation gives the regulator the option of setting prices based on the costs of
an efficient firm or on costs based on an international benchmark reflecting
best practice.
d) Price cap regulation reduces the need for micromanaging the operations of the
regulated firm.
e) In the early stages of competition price cap regulation protects consumers and
competitors by preventing the regulated firm from increasing the prices of its
monopoly services and using the revenue derived from increased prices in the
monopoly services to cross-subsidise those services subject to competition.

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Pol Gonzalez Feliu Group A6 Public Sector Economy

Cons:

a) The cost or total effort required to implement and apply price cap regulation
b) The potential to set the price control too tightly or loosely
c) The possi le lo eri g of the i u e t s ser i e le els.

RATE-OF-RETURN REGULATION:

Pros:

a) Rate-of-Return regulation was mainly used due to its ability to be sustainable in

the long-term and resistant to changes in the company's conditions as well as
its popularity among investors. While regulation of this type prevents
monopolies with the potential to make large profits from doing so, such as
electricity companies, it provides stability. Investors will not make as large
dividends off of regulated utility companies; however, they will be able to make
fairly constant, substantial returns despite fluctuations in the economy or firm
composure. Investor risk is minimized since the regulator's prudence in price
setting is constrained by the method used to set the regulation rate. Therefore,
investors can depend on consistency, which can be an attractive offer,
especially in a volatile world market.

Furthermore, regulation of this sort protects the firm from negative public
opinion while providing the consumer with ease of mind. Throughout history,
due to their large profits, public opinion has turned against monopolies, which
eventually resulted in severe anti-trust laws in the early 20th Century.
Unregulated monopolies such as Standard oil that pulled vast profits quickly
became the subjects of negative public opinion, the original source of
regulation of monopolies. With rate-of-return regulation, consumers can rely
on the government to ensure that they are paying fair prices for their electricity
and other regulated services, and not feeding into a business of trusts and
greed.

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Cons:

b) The central problem with rate-of-return regulation, the reason most countries
with economic regulation have switched to alternate methods of regulating
such firms, is that rate-of-return regulation does not provide strong incentives
for regulated firms to operate efficiently. The main form of this weakness is the
Averech Johnson effect

Firms regulated in this manner will engage in disproportionate capital

accumulation, which in turn will heighten the price level allotted by the
government regulator, raising the firm's short-term profits. By spending on
unnecessary capital and other extravagant expenses, the firm's revenue
requirement is raised as a result of both an increase in operating expenses and
depreciation costs. Depreciation costs rise due to the fact that as a firm obtains
more capital, that physical capital will depreciate over time, therefore raising
the overall depreciation cost. In order to subvert the system, regulated-
monopolies can purchase capital they don't necessarily need or use, which will
be left in the factory merely to depreciate, thereby raising their regulated price
level as allocated by the government.

Section 3

Regulation is needed in special occasions. Regulation gives rise to a system where

incentives are twisted. Our abuses of dominant positions express a inflexible antitrust
orientation.
We should not fall into a trap if active intervention, whenever possible, competition is
to be preferred to detailed regulations as the best mechanism to avoid inefficiencies
and foster productivity growth.
The regular for assessing whether a given practice is harmful to competition should be
consequential from the effects of the practice on consumers. If we think of
competition as a rule in which the different suppliers compete to sell their products to
contestants on the other side of the market, then the benefits earned by the other side
of the market will deliver a measure of how well competition works. In the other hand,
competitors should not be protected from competition by the authority regulation or
intervention. The competition authority must evaluate these problems without

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prejudice for any specific configuration. Focusing on foster productivity and growth,
consumer welfare must no fall in the trap of seeing competition policy as a tool of
active policy intervention meant to correct the inefficiencies related with monopolies
and oligopolies so as to maximize some measures of welfare.
So we can argue that regulation is needed only to avoid inefficiencies in foster
produ ti it a d gro th. Without regulatio it ould t e possi le to i pro e the
growth of the society and to go forward to progress.

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