Competition and the State (Global Competition Law and Economics) - Hardcover

Hardcover

ISBN 10: 0804789398 ISBN 13: 9780804789394

Publisher: Stanford Law Books, 2014

Synopsis

Competition and the State analyzes the role of the state across a number of dimensions as it relates to competition law and policy across a number of dimensions. This book re-conceptualizes the interaction between competition law and government activities in light of the profound transformation of the conception of state action in recent years by looking to the challenges of privatization, new public management, and public-private partnerships. It then asks whether there is a substantive legal framework that might be put in place to address competition issues as they relate to the role of the state. Various chapters also provide case studies of national experiences. The volume also examines one of the most highly controversial policy issues within the competition and regulatory sphere―the role of competition law and policy in the financial sector.

This book, the third in the Global Competition Law and Economics series, provides a number of viewpoints of what competition law and policy mean both in theory and practice in a development context.

About this title

About the Author

Thomas K. Cheng is Associate Professor of Law at the University of Hong Kong.

Ioannis Lianos is the City Solicitors' Trust Reader in Competition and European Union Law at the Faculty of Laws, University College London.

D. Daniel Sokol is Associate Professor of Law at the University of Florida Levin College of Law.

Excerpt. © Reprinted by permission. All rights reserved.

Competition and the State

By Thomas K. Cheng, Ioannis Lianos, D. Daniel Sokol

STANFORD UNIVERSITY PRESS

Copyright © 2014 Board of Trustees of the Leland Stanford Junior University
All rights reserved.

ISBN: 978-0-8047-8939-4

Contents

Contributors, 
Introduction, 
PART I: CONCEPTUALIZING AND RE-CONCEPTUALIZING THE INTERACTION BETWEEN COMPETITION LAW AND GOVERNMENT ACTIVITIES, 
1. Privatization and Competition Policy (Alexander Volokh), 
2. Toward a Bureaucracy-Centered Theory of the Interaction between Competition Law and State Activities (Ioannis Lianos), 
3. Competition Issues and Private Infrastructure Investment through Public-Private Partnerships (R. Richard Geddes), 
PART II: IS THERE A NEED FOR A SPECIFIC SUBSTANTIVE LEGAL FRAMEWORK IN DOMESTIC AND INTERNATIONAL COMPETITION LAW?, 
4. State-Owned Enterprises versus the State: Lessons from Trade Law (Wentong Zheng), 
5. What Drives Merger Control? How Government Sets the Rules and Play (D. Daniel Sokol), 
6. Antitrust Enforcement and Regulation: Different Standards but Incentive Coherent? (Alberto Heimler), 
7. International Law and Competition Policy (Paul B. Stephan), 
8. The Foreign Trade Antitrust Improvements Act: Further Limitations on the Ability of the Antitrust Regime to Promote Consumer Welfare (Joseph P. Bauer), 
PART III: JURISDICTIONAL EXPERIENCES, 
9. Competition Advocacy of the Korean Competition Authority (Dae-Sik Hong), 
10. Competition and the State in China (Thomas K. Cheng), 
11. State Aids in European Union Competition Law (Leigh Hancher and Francesco Salerno), 
12. Australian Experience with Competition Law: The State as a Market Actor (Deborah Healey), 
13. Merger Analysis and Public Transport Service Contracts (Philippe Gagnepain, Marc Ivaldi, and Chantal Latgé-Roucolle), 
Notes, 
Index, 

CHAPTER 1

Privatization and Competition Policy

Alexander Volokh

Why are we discussing privatization in a book about competition policy? Because the scope of government and the role of the state are central to broader issues of competition. Privatization of monopolies without sufficient antitrust protection has been a recurring complaint among critics of privatization. So, on the other side, has been anticompetitive behavior by state-owned enterprises that often are not subject to antitrust at all. More theoretically, antitrust law may focus on certain problems and choose to ignore others as being unrealistic because of an assumption that firms behave as profit maximizers. But given the mass of public choice literature exploring what governments supposedly maximize, as well as empirical evidence that privatization often increases productivity and profitability, this may be a bad assumption when firms are owned (or even heavily regulated) by government.

This chapter, therefore, explores the links between privatization and competition policy. First, in Section I, I explain why privatization is even relevant at all—a question economists paid surprisingly little attention to before a quarter-century ago. I survey theoretical models and empirical results, discuss the relevance (if any) of theory to policy, and show how privatization can be a catalyst for various forms of social change. Many policies are complementary to privatization, in the sense that the design of those policies systematically affects the effectiveness of privatization; two of the most important complementary policy areas are corporate governance and competition policy, and most generally, privatization works better when accompanied by liberalization. Moreover, since failures in both of these areas lead to distortions relative to the imaginary "perfectly competitive" outcome, good corporate governance and good competition policy are to some extent substitutes. I briefly address the connection between privatization and corporate governance in Section II and discuss at length the interplay between privatization and competition policy in Section III.

I. Privatization and Its Possible Irrelevance

A. Irrelevance?

Privatization has a long history. Peter Drucker advocated "reprivatization" in 1969, but the term privatize and its derivatives were used even earlier to refer to the sell-off of government assets in West Germany in the 1950s and in Nazi Germany in the 1930s and 1940s. Even before that, as far back as the 1920s, the term denationalization was used. And asset sales (or giveaways) and contracting out existed even before there was a word for them; vast public lands were privatized in the United States under the preemption and homestead acts of the mid-nineteenth and early twentieth centuries. Jeremy Bentham envisioned privately managed prisons in the late eighteenth century, and contracting out—in tax collection and many other public services—goes back to ancient Greece and the Roman Republic.

The history of the theory of privatization, though, is quite short. For much of its history, privatization was "a policy in search of a rationale." Early debates over privatization were unrigorous, and the era of economically sophisticated discussion of privatization probably began in 1987, when David Sappington and Joseph Stiglitz pointed out that, in a simple model, whether assets are owned publicly or privately is irrelevant.

To simplify their model slightly, suppose the government is considering whether it should own an asset. The asset produces a quantity Q, with valuation V (Q) (which could encompass any objectives, including distributional ones). The government could induce private providers to produce the optimal quantity by simply paying a price P (Q) = V (Q). (Many other contracts will do just as well—for instance, "Produce the optimal quantity Q* in exchange for a price that guarantees you zero economic profits, or we boil you in oil"—but the Sappington-Stiglitz proposal has the advantage that the government doesn't need to know costs.) The private provider would thus get paid the entire social benefit of his production, but the government can extract this rent byauctioning the right to produce among potential noncolluding risk-neutral suppliers with symmetric beliefs about the least-cost technology.

One might add that a government manager can be incentivized the same way with a wage W (Q) = V (Q), so all ownership modes are equivalent. Generalizing still further, Q could be multidimensional and indicate not just quantity but any attribute of how the business is run. Any public-sector rules can be imposed by contract or written into regulations; government enterprise, contracting out, and a regulated market are thus potentially equivalent in every way.

From this perspective, much of the conventional wisdom about privatization appears—if not wrong, at least undertheorized. Private firms may have better capital-market monitoring—but capital-market monitoring has its own problems, and why can't the government retain any advantages of such monitoring by only owning partial shares in firms? Private firms may have harder budget constraints, but why can't the government shut down failing agencies or, alternatively, as recent events remind us, bail out failing private firms? Private firms may have stronger profit-based incentives, but why can't the government simulate these using public-sector compensation schemes with high-powered incentives? (The last two questions combined could be summarized as "Why privatize when one can liberalize instead?") Governments might undermine the investment incentives of public agencies by redirecting their profits to other uses, but can't shareholders do the same? Public agencies may have goals that are hard to specify, but isn't this also a problem when the government regulates private firms? Governments may be subject to interest-group lobbying, but can't that lobbying also affect contracts or regulation of private firms? Governments are better positioned to accomplish social goals, but can't they also accomplish those goals through contract or regulation?

One can easily apply these points to various concrete examples. Why should the U.S. Postal Service be public rather than contracted out to Federal Express or the United Parcel Service, or even left to a regulated private market? The USPS takes all comers and charges uniform postal rates, but that could be written into regulations. The USPS loses money, but FedEx could charge its customers the same as the USPS right now and collect its deficit in contract fees from the government. On the other hand, the government could regulate prices and subsidize entrants in a private market. The quality and speed of postal delivery can be easily checked and made the subject of rewards and punishments by mailing test letters and packages. On this last point, one could make similar arguments about the Transportation Security Administration, thenationalization of which was rushed through post-9/11 with very little appreciation of Sappington-Stiglitz.

Of course, the best way to use any equivalence theorem is as a checklist to see how differences emerge when the assumptions of the theorem do not hold up. One issue is that the rent-extraction auction might not work well because of, say, collusion, asymmetric beliefs, risk aversion, or the winner's curse. To the extent that the winning bidder retains some rents, P (Q) = V (Q) privatization potentially implicates distributional concerns—and requires raising government revenue, with the associated deadweight loss of taxation.

But the literature has mostly focused on the most obvious line of inquiry: V (Q) might be indescribable because of the sheer number of possible contingencies (really, V (Q) is V (Q, θ), where θ, a parameter describing the state of the world, can take too many values). V (Q, θ) might even be unknown until θ occurs (after the contracting stage); Q might be unverifiable; the contract P (Q) = V (Q) might be imperfectly enforceable; and so on.

In short, the P (Q) = V (Q) contract is trickier than it seems. This idea has a name—the theory of incomplete contracts—which was pioneered by Sanford Grossman, Oliver Hart, and John Moore in a theory-of-the-firm context and is now the centerpiece of privatization theory as well. It is now second nature to privatization theorists that "any organizational mode can be copied by any other organizational mode through a complete contingent contract. Therefore, if there is any difference, it must be due to the fact that only incomplete contracts are feasible at the stage of privatization."

B. Relevance?

Sappington and Stiglitz did not present a theory of government behavior that would allow a comparison of government and private ownership; that is the story of the post-1987 theoretical research. I summarize a few of these models below to give a flavor of the sorts of contractual incompleteness that could support a difference between different modes of ownership.

One possible difference between public and private agents, suggested by Jean-Jacques Laffont and Jean Tirole, is that the private manager has to answer to two principals—the government and the shareholders—while the public manager answers to only one. The disadvantage of private management is that cost-reducing effort is suboptimal: "The multiprincipal situation dilutes incentives and yields low-powered managerial incentive schemes." The advantage is that the private manager has greater investment incentives because the shareholders are less likely to expropriate the manager's investment to secure greater social benefits. So privatization trades off these two types of effort and investment.

Another difference, suggested by Klaus Schmidt, is that the government might have better access to inside information about the agent's finances when the agent is public. Knowing the agent's costs can lead to bad incentives. If costs turn out to be high, it will be ex post optimal to subsidize the enterprise, but this leads to low ex ante incentives to reduce costs. A government ignorant of costs will not subsidize as much and will inefficiently shut down some enterprises, but at least cost-reducing incentives will be improved. The trade-off is between productive and allocative efficiency.

Another strand of the literature, spawned by Hart, Andrei Shleifer, and Robert Vishny (HSV), stresses the importance of residual control rights—that is, the right to do whatever is not prohibited by the contract. A contract to run a government program—say, a prison—only specifies a basic service, but the agent can invest in thinking up various innovations to the service. Some innovations cut costs (and, by assumption, reduce quality); private managers spend too much effort thinking of these because they keep every dollar saved. Other innovations improve quality (and, by assumption, cost more). Private managers will be able to appropriate some of the net benefit by renegotiating the contract with the government. Their incentives to think up such innovations are suboptimal, but at least they are better than those of public managers, who have a more precarious bargaining position. Privatization trades off these two types of innovation.

The HSV model has been quite influential. Hart himself used it in later work on public-private partnerships (PPPs), where he discussed whether the contractor who builds the facility should be the same as the one that runs it. Patrick Schmitz also used an HSV-style model to discuss the advantages of joint ownership, and Timothy Besley and Maitreesh Ghatak used it to discuss privatization in the presence of altruistic providers.

Most models assume a benevolent government. (Benevolence, in economists' lingo, invariably means utilitarian social welfare maximization or something like it.) In some models, nonbenevolence makes privatization more desirable, because private ownership limits the scope of politicians' private agendas. But a nonbenevolent government can also transfer resources to its supporters by nonbenevolently regulating private firms, so the superiority of privatization does not necessarily follow. As Shleifer and Vishny point out, "With full corruption the allocation of control rights and cash flow rights between managers and politicians does not affect either the efficiency of the firm or the transfers it receives." Moreover, they say, if the government continues to regulate firms heavily, privatization (the transfer of cash-flow rights) "may actually make things worse. Politicians continue to use their control of regulated firms to pursue political objectives, but it is now less costly for them to do so." Transferring control rights, not just cash-flow rights, to managers—a process that Shleifer and Vishny call "commercialization"—may be necessary for privatization to work. So the costs and benefits of privatization depend on the precise form of nonbenevolence.

C. Empirics and the Uses of Theory for Policy Makers

No serious model unambiguously predicts benefits from privatization, so empirics are a good check. Unfortunately, many empirical studies are less useful than they may appear because the choice of enterprises to privatize is nonrandom. Profitable firms might be privatized first, whether because they're the most likely to restructure, because such restructuring will generate less unemployment and be more politically palatable, because buyers are easier to find for profitable firms, or because the sale of profitable firms generates more money. Alternatively, sometimes it is unprofitable firms that are privatized—for instance, through liquidation. Either way, naive estimates are misleading.

Thus, the best empirical studies are those that use instrumental-variables approaches or otherwise address selection bias. A recent review by Saul Estrin and colleagues, which takes selection bias into account, concludes that in central and eastern Europe, privatization has mostly increased productivity; the effect is much smaller in the countries that belong to the Commonwealth of Independent States (which now includes all former Soviet republics except the Baltic states and Georgia). Privatization also has a nonnegative effect on profitability in central and eastern Europe, the former Soviet countries, and China, though the size and significance of the effect depends on the type of ownership: concentrated domestic private ownership, managerial ownership, and foreign ownership are good.

An earlier review by William Megginson and Jeffry Netter concluded that, for nontransition economies, privatization increases "output, efficiency, profitability, and capital investment spending" and decreases leverage; the studies "are far less unanimous regarding the impact of privatization on employment levels in privatized firms." To prevent the political fallout from investors who lost money after buying shares in privatized firms, governments engaging in their first large share-issue privatizations typically "establish (or augment)" an SEC-like agency, establish regulatory bodies for natural monopolies, improve disclosure rules, and otherwise modernize their corporate governance. Not that all the evidence cuts the same way: where Rafael La Porta and colleagues have found government ownership of banks negatively associated with growth rates, Svetlana Andrianova and colleagues have recently found an association in the opposite direction. (But, consistent with Sappington-Stiglitz, Andrianova does not rule out that the effect may weaken with increased quality of regulation.)

It is apparent from these results that privatization does not exist in a vacuum. The results are different in Russia than in the Czech Republic, or when ownership is foreign versus domestic, because institutional details matter—many more than are apparent from reading the models. Those who are familiar with the reward structure of the economics profession will not be surprised that the theoretical models focus on a few factors. There is no glory or prestigious publication in finding that the case for privatization depends on the competence or public spiritedness of public servants: the point is both obvious and politically charged. Nor is there glory or prestigious publication in finding that the desirability of privatization depends on the quality of corporate governance or antitrust law in the private sector—or on the presence of civil service protections, public-employee unions, APA/FOIA-type statutes, or procurement regulation in the public sector. In principle, any problems along those lines can be fixed by statute (or by constitutional amendment or changes in judicial interpretations), so if those are contractual incompletenesses, surely they are not interesting ones.

(Continues...)

Excerpted from Competition and the State by Thomas K. Cheng, Ioannis Lianos, D. Daniel Sokol. Copyright © 2014 Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of STANFORD UNIVERSITY PRESS.
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Edition details

• Publisher: Stanford Law Books
• Publication date: 2014
• Language: English
• ISBN 10: 0804789398
• ISBN 13: 9780804789394
• Binding: Hardcover
• Edition number: 1
• Number of pages: 304
• Editor: Sokol D. Daniel, Cheng Thomas K., Lianos Ioannis