Privatisation

1
Privatisation Trust economists?

• Sure cant

2
Economists nirvana

• Price and quantity set by market
• Under normal circumstances, a competitive market
  structure will allocate resources in such a way
  as to produce the goods and services which
  consumers value most highly and are prepared to
  pay for, and it does so at the lowest possible
  cost in terms of resource use. Thus, competition
  policy is based on the belief that a competitive
  market will result in economic efficiency and
  increased social welfare. (Allan Fels, Chairman
  ACCC, Lessons from International Experience
  Competition Policy The Road Ahead for Egypt, 24
  May 2001)

3
How it works

• But if monopolies get in the way

Price

• And government monopolies?
• Worst of both worlds
• Arbitrary price
• Arbitrary quantity
• No tendency to equilibrium

• G1?

Supply
Monopoly Price

• G3?

Pe
Marginal Revenue

• G2?

Demand
Qe
Quantity
Monopoly Quantity
4
So the ideal is

• Competitive pricing Price equal to marginal
  cost of production
• Output sold at price of producing last unit
• Price equal to marginal benefit of consumption
• Market price represents marginal benefit to
  society of last unit consumed
• Equality of marginal benefit and marginal
  cost ensures gap between total benefit and
  total cost is maximised
• Competitive pricing thus maximises social
  welfare

• Price equals marginal cost means price set by
  supply and demand

5
And the bogeyman is

• Monopoly pricing
• Price greater than marginal cost of production
• Monopoly sets marginal cost equal to marginal
  revenue
• Change in total revenue due to a change in output
• Since price must fall to sell additional units,
  marginal revenue less than price
• Output less than ideal level price higher
  welfare lower
• Price set by intersection of marginal revenue and
  marginal cost, not supply and demand

• Government monopoly even worse
• Not even subject to monopoly market discipline

6
So the solution is

• Privatise government utilities, and/or let market
  force competitive price where price equals
  marginal cost
• Well, thats the theory, which the ACCC takes
  seriously

it's all a load of bollocks...

• I detected some sense of impatience with
  academic theories, a desire to hear how it works
  in the real world. If that is the expectation,
  then what I say, at least at first, may
  disappoint you. Thats because one of my
  strongest guiding beliefs is that there is
  nothing more practical than theory The generally
  used framework for competition regulation is
  applied economics (Rod Shogren, Commissioner
  ACCC, Telecommunications regulation in practice
  Perspectives of a practitioner, 1999 Conference
  of Economists Business Symposium)
• Theres just one problem

7
Flaws in theory of competitive markets

• Proposition that competitive markets set price
  equal to marginal cost nonsense
• Check the big picture

Where does this loss come from?
Monopoly profit level
Competitive marketaggregate profit level
Alleged competitivemarket decision point
Monopoly decision point
8
Flaws in theory of competitive markets

• Full logical argument in Chapter 4, Size Does
  Matter
• Mathematical argument on website

Anyone forMathematica?

• Bottom line
• Theory of competitive markets based on simple
  mathematical flaw
• Corrected, theory predicts exactly the same price
  and output for competitive market as for monopoly
• On properly amended economic theory, Fels belief
  (that a competitive market will result in
  economic efficiency and increased social
  welfare) completely unfounded.
• Competition policy much ado about nothing
• And it gets worse

9
A little knowledge

• Many other building blocks of economic theory
  already shown to be unsound
• Undermines simplistic faith in economic theory
  professed by ACCC (one of my strongest guiding
  beliefs is that there is nothing more practical
  than theory)
• Key issue re privatisation instability of
  multi-commodity spot markets
• Sargan (1958), Jorgenson (1960, 1961, 1963),
  McManus (1963), Blatt (1983) prove model
  unstable
• Either prices, quantities, or both, must diverge
  from equilibrium

10
Multi-market instability

• Given instability, a conjecture
• If basic commodity (electricity, water, etc.)
  priced by spot market, it will display the
  instability of underlying multi-market economy
• Forcing spot market pricing on utility
  wholesalers probably leads to price spikes
• Spot pricing may cause bankruptcy of suppliers
• NSW Victoria late 1990s, California 2000
• Competitive market model probably worst one that
  could be imposed on essential utilities
• Killing us with misplaced kindness

11
What does the ACCC think it is doing?

• The virulence and persistence of the attacks on
  the Commission raises the question of motive. Do
  the attackers want the unfettered right to
  establish monopolies so they can dominate the
  market and, by raising prices, earn greater
  profits? If the big business critics were
  serious about promoting the development of large
  internationally competitive Australian companies
  it would acknowledge the benefits of competition.
  Would Australias big companies be
  internationally competitive if they had to secure
  their raw materials from a monopoly supplier?
  (Australia-Israel Chamber of Commerce, Boardroom
  Lunch Allan Fels Mergers Market Power,
  Sydney 15 March 2001)
• Doing good even though the medicine may taste bad

12
What is the ACCC actually doing?

• What economics thinks average costs look like

• What 95 of firms say average costs look like

Impose PMC and
The model tellsyou price falls quantity
rises,firms makelower profits
Total
Marginal


P
Total
P
Fixed
Fixed
The real worldtells you pricewont cover fixed
cost, firms (andpublic utilities)make losses
Marginal
MR
Q
Q

• Marginal costs highest, and determine price/output

• Marginal costs lowest, P must be gtgt MC to cover
  fixed costs

13
What is the ACCC actually doing?

• Imposing impossible theoretical model on actual
  business
• Vast majority of firms would go bankrupt if
  priced at marginal cost
• Especially true of electricity, water, gas
• Obsession with competition means lip service paid
  to important issues of economies of scale,
  synergies
• Could reduce capacity of Australian industry to
  develop dynamically, in impossible pursuit of
  static efficiency goal
• Industry public opposition partly justified,
  because
• Theres nothing more impractical than a bad
  theory!
• virulence and persistence of the attacks
  reflects frustration with ignorance of
  economists however

"At least we 'trancendental capitalists' can make
a buck out of privatisation..."
14
What should ACCC really be doing?

• Assess each market on merits rather than one
  size fits all (small only!) approach of economic
  theory
• Empirical work confirms models of pricing wrong
  (Hall Hitch 1939, Eiteman 1947, 1948, Bishop
  1948, Haines 1948, Eiteman Guthrie 1952, Means
  1972, Lee 1996, 1998, Blinder 1998)
• Over 89 per cent indicated that marginal
  costs either declined or stayed constant with
  changes in output Finally, only four of 200
  enterprises had both elastic demand curves and
  increasing marginal costs. (Downward Lee 2001,
  reviewing Blinder)
• Fixed costs appear to be more important in the
  real world than in economic theory. (Blinder)

15
What should motivate utility providers?

• Not simple profit motive cost minimisation
• Security of supply of basic commoditiesthose
  which are inputs into all production
  processesmore important than price
• Especially essential services Electricity, Gas,
  Water, Sewerage
• Sheils Waters Fall (Pluto Press 2000)
  illustrates what happens when supply of essential
  commodity corporatised/privatised

Privatised utilities?
We can't afford them!
16
Onya Norway!
www.plutoaustralia.com
www.debunking-economics.com