After years of deregulation, the issue of regulation has become topical again in Georgia. The new government has announced its intention to restore the antimonopoly service which was abolished in 2005 as part of deregulatory reforms implemented by the former government. Regulatory advocates argue that reversal of the deregulatory trend is necessary because the Georgian market has seen the emergence of monopolies and oligopolies since the country disbanded its antimonopoly service.
Naturally, the free market is not perfect and sometimes resources are redistributed inefficiently because companies fail to take into account the so-called social costs. Using popular terminology, market failure is caused by “information asymmetry.” In the view of the new parliamentary majority and a number of scholars, government can rectify that market flaw by regulating the economic behavior of private companies.
In theory, a “wise” government can do many things to improve the market flaw of inefficient distribution of resources. For example, it can institute regulations to protect the environment from pollution, to ensure food safety, to create safe working conditions and to guarantee long-term employment, etcetera.
In reality, regulations are the result of political decision-making processes in democratic societies. Governments that come to power via democratic elections are supposed to represent the interests of the entire society. Yet, the special interests of those sectors that governments try to regulate are often represented more broadly than the interests of those people who are supposed to gain additional benefits as a result of government regulation.
The larger segment of the society is unfamiliar with the activities of regulatory agencies whereas companies potentially subject to regulation are well aware of how regulations will affect their interests. The society remains generally neutral while companies likely to be regulated engage actively in the political process in order to influence regulatory agencies. Regulations actually serve the interests of specific companies rather than improve market flaws.
In contrast to competitive market conditions, a monopolist or cartel reduces the supply of a product to the volume at which marginal costs of the monopolist or cartel match its marginal revenues. As a result, the monopolistic price corresponds to the demand price based on reduced product availability. In any possible situation, this combination of price and volume ensures maximum revenues for the monopolist.
The philosophy underlying market regulation is that market competition lowers the market price and increases the customer base. In other words, the society pays more for monopolistic products than it does for products which are competitively available on the market. As a result, so-called social losses are realized when an “invisible hand” distributes resources inefficiently on the market.
The picture becomes graver in the case of a cartel. That happens when a group of influential producers agree to limit competition by fixing prices at a higher amount than would exist if there were healthy competition among them. One often hears complaints that the fuel and pharmaceutical markets in Georgia are such oligopolies.
No one argues that competitive markets become oligopolistic or monopolistic. But just how capable is an antimonopoly service of eradicating social losses caused by anticompetitive market conditions?
In simple terms, let’s assume that monopolies – both natural and artificial – operate in many sectors of the Georgian economy. The following analysis shows that any attempt by the new government to regulate the market will actually make the market distribution of resources more inefficient than it is today because of monopolistic companies.
1. The function of a regulatory agency is to expose a monopolistic price, not a monopolistic company. The mere existence of a monopoly does not necessarily reduce social benefit – only monopolistic pricing generates losses. To establish a monopolistic price, the regulatory agency must first study market demand; that is, it must determine how much of a product can be sold at this or that price. The agency has to establish consistency between the price of demand and the volume of demand. Then, the agency must seek information about a company’s operating costs and revenues and, based on that data, must calculate marginal costs and marginal revenues for that company. The agency has to calculate at what volume of sales that company’s marginal costs equal its marginal revenues and, using that calculation, has to establish the correspondence between the limited volume of demand and the price of demand. The obtained result must be compared to the market price and, only if the two coincide, can it be established that the market price is really monopolistic. How feasible is it to do that? That is almost impossible to do.
2. Let’s assume that the regulatory agency is so “wise” that it has managed to carry out all that almost-impossible operation. What is the next step? Possible regulatory responses include sanctions, fines, price restrictions. But is it possible to eradicate social losses by applying any of those penalties to specific companies? To that end, the size of the fine would have to match precisely the size of the social losses and the revenue received by the agency in the form of a fine would then have to be returned to that precise segment of society that sustained losses. In any other case, the mechanism of resource distribution would still be inefficient and would generate more losses than had been the case with the monopoly. No matter how “wise” the regulatory agency may be, it will never be able to achieve that objective.
One of the most common regulatory responses to monopolistic pricing is application of price restrictions. If monopolistic pricing is revealed, the regulatory agency can demand that the monopolist lower its price on the market to a government-established “price ceiling” or upper-price limit. In the ideal case, the upper limit would equal the price for that volume of demand at which the monopolist’s marginal costs equal the market demand. But what happens if the price does not reach what would be the equilibrium? The volume of demand would then exceed the volume of supply, which would result in shortages, long queues for product and the emergence of a shadow market in which customers anxious to obtain a single-source product would be willing to pay a much higher price than they would have paid even with monopolistic pricing. In such a case, the resultant social loss would be way higher than the loss resulting from an inefficient distribution of resources on the monopolistic market.
Let’s now assume that the regulatory agency is so “wise” that it sets the ideal upper-price limit. In so doing, the agency effectively legalizes the monopoly because any outside firm seeking to enter that market would encounter an insurmountable barrier in the form of the government-imposed price ceiling. Thus, the very agency fighting monopolies ends up creating them instead.
3. Even assuming that the “wise” regulatory agency is able to achieve all theoretical possibilities, then to what extent can the money paid by taxpayers to maintain that agency ever be justified? Is that even possible to calculate?
Considering all the variables just discussed, the best-case scenario would not only produce social losses, it would also incur significant additional losses from the cost of maintaining both the agency and the legalized monopolies it creates.
Because of the difficulties involved in revealing monopolistic prices, the main task of regulatory agencies worldwide is to combat cartels. It is easier to uncover underhanded cartel deals than it is to detect monopolistic pricing. The regulatory agency ends up actually spending its time conducting investigative activity and not eradicating social losses.
Regulatory advocates contend that disbanding cartels reduces social losses. That reasoning certainly seems logical, but no one really knows what will happen to social losses after the cartel is disbanded.
Let’s analyze all the instruments that must be used to disband a cartel. In every case, there has to be a state mechanism to impose a host of punitive measures – from setting the upper-price limit to arresting managers of the cartel. There is no question that a cartel can be disbanded. But at what cost? After that, will the collusive companies still be able to operate on the market? Social loss not only consists of customer’s lost savings, it includes the producer’s lost savings too. Does it matter to the overall societal welfare whether customers’ living standard deteriorates or that of producers? It is impossible to deal with one without damaging the other.
When making decisions, politicians fail to take into account opportunity costs; that is, the cost of benefits lost by choosing one alternative over another. For instance, politicians decide to provide a four-million-strong society with free health care services. Perfect! But at what cost? What is the opportunity cost of that “free” health care? Similarly, let’s disband a cartel. Fine! But at what cost? What is the opportunity cost of that? No one has answers to those questions because those costs are very difficult to calculate. Therefore, no one knows whether social losses will increase or not after the cartel is disbanded.
Antimonopoly service is, as a rule, established under the umbrella of a pro-competition policy. That implies the enactment of antimonopoly legislation which mainly targets cartels. It is difficult to oppose the logic of that when a cartel deal is equalized to some type of criminal conduct. Assuming that potential wrongdoers will avoid committing crimes, competition is thereby promoted. In principle, it is impossible not to agree with advocates of regulation in this line of reasoning – here the government can actually help to avoid market failure. But what does an antimonopoly service have to do with that? What is the function of that service? Is it fighting crime or is it eradicating social losses?
An antimonopoly service is a regulatory agency which must regulate the market behavior of companies in such a way as to ensure the maximum welfare of the society. It is that very objective that is impossible to achieve. As for fighting crime, that task is already performed by law enforcement bodies of the government and that must be a key obligation of any state to its society.
One should also note that antimonopoly legislation does not always contribute to strengthening competition. For example, how correct was the divestiture of Microsoft into several fully integrated companies? Those companies in due time were purchased because they were unable individually to withstand international market competition. In the beginning, a successful company won and bought other companies, heavily invested in those companies, and increased their collective efficiency. A court decision then dismantled that gigantic pyramid and created a new reality on the market. How credible to assume that those companies which failed to counteract international market competition would today be supplying customers with products that would improve their wellbeing?
As a practical matter, oligopolies and, even more so, monopolies would be of only temporary duration. In the case of monopolies, an off-market player that sees a potentially high benefit from a specific business will try to enter the market if no artificial barrier to market entry has been erected. The only barrier that might prevent a firm from entering the market is market price. That’s why a monopoly cannot exist for a long time.
For example, one often hears that gas prices are too high in Georgia, that it costs an entrepreneur GEL 1.60, on average, including taxes, to import gasoline which is sold by that entrepreneur for GEL 2.10. Let’s assume that’s true. What impedes, say, another entrepreneur then from investing in that very business in order to yield a GEL 0.60 profit margin? The answer to that question is the government, which may have a specific interest in that business and, in return for certain benefits, may protect existing companies by using the power of the government to establish barriers that prevent new companies from entering the market.
The life of monopolies is extended by their protection or legalization. It is the government, not the market, which prolongs the life of a monopoly. When the government creates yet another institution to fight against monopolies, it is facilitates creation and legalization of monopolies.
Similarly, in the case of an oligopoly, a high-profit margin stimulates outsiders to enter an oligopolic market. Even more, an underhanded agreement among companies cannot last for long. Companies participating in such an agreement tend to want to violate that agreement by selling more products at a higher price without consent of colluding competitors.
Those conditions make cartel agreements also a temporary arrangement. Declaring war against them, even on the premise that antimonopoly legislation promotes competition, is inexpedient. That objective is not worth wasting resources and time.
The most beloved argument of regulatory advocates is: “Why then is an antimonopoly service up and running in every developed country with a market economy?” My answer to that is what I said at the beginning of this article: Because in a democratic society, regulations are generally the result of political decisions.
That assumption can be supported by the logic of American economist James Buchanan, a founder of the Center for Study of Public Choice at George Mason University in Virginia. Namely, political parties in democratic societies come to power by winning elections. Politicians must gain the trust of the majority because their victory depends on the support of ordinary voters. In general, voters are largely ignorant of regulatory processes. Voters only know that establishing a new regulatory body will increase their taxes by just a few laris. Those few laris condition voter neutrality toward the regulatory issue. We can conventionally call that public interest. However, a few laris paid by each person add up to millions of laris and, here, the interest of those industrial actors whose behavior must be regulated is quite high. We can conventionally call that special interest.
In order to win, politicians have to take into account both public and special interests. That is because regulation means benefitting one at the cost of the other. The price which the society must pay for the introduction of regulations does not depend on how equal the marginal revenue of regulation is with its marginal cost. (If it were so, a theoretical chance would exist that a market flaw could really be improved by a “wise” government).
Consequently, a politician must compare the marginal political benefit with the marginal political cost of those people who will sustain damages as a result of regulations. The political benefit slants toward special interest as long as the society ignores the regulation price. The higher the number of regulations which a political party promises to establish, the faster the special interests increase. At the end of the day, regulations result from decisions made in the political process which serve to benefit less the generous aims for which they were initially intended.
Thus, a regulatory agency can never become “wise” and there is not even a theoretical chance of rectifying the inherent market flaw.