3.6 Government Intervention

Question 1

What does the CMA stand for?

Answer 1

The ​Competition and Markets Authority

Question 2

What do the CMA do?

Answer 2

​● Work to promote competition for the benefit of consumers and investigate mergers and breaches of UK and EU competition law,
● Enforce consumer protection law and bring criminal cases against individuals who participate in cartels.

They are able impose financial penalties, prevent mergers taking place and force businesses to reverse actions already taken.

Question 3

How can the CMA punish firms?

Answer 3

● Impose financial penalties
● Prevent mergers taking place
● Force businesses to reverse actions already taken.

Question 4

How are mergers investigated in the UK?

Answer 4

● In the UK, mergers are assessed in terms of the specific circumstances of each case, considering whether there will be a ​substantial lessening of competition ​(SLC).
● The CMA will consider the likely competitive situation if the merger goes ahead compared to if it does not, and the merger will be approved if its potential benefits are greater than its costs
● A merger is investigated if it will result in market share greater than 25% or if it meets the turnover test of a combined turnover of £70 million or more

Question 5

Why was Tesco’s takeover of Booker allowed?

Answer 5

As the CMA believed the impact on competition would not be too high since supermarkets are in a hypercompetitive industry

Question 6

Why did the European Commission block the merger of Ryanair & Aerlingus in 2010?

Answer 6

As they would control more than than 80% of all Europe flights from Ireland.

Question 7

How can price regulations be imposed on monopolies?

Answer 7

● Regulators can set price controls to force monopolists to charge a price below profit maximising price, using the RPI-X formula. X represents the ​expected efficiency gains of the firms and the aim is to ensure firms pass on their efficiency gains to consumers. This is used in the airport industry
● Arguably, a better system is ​‘RPI-X+K’​, where K represents the level of ​investment​. This is used in the water industry and has allowed investment of £130bn.

Question 8

How can price regulations on monopolies be helpful?

Answer 8

● It gives an incentive for firms to be ​as efficient as possible as if they can lower costs by more than X they will see increased profit
● It ​prevents excessive prices and ensures that gains are passed onto the consumer

Question 9

What are some issues of price regulation of monopolies?

Answer 9

● Difficult to know where to set X due to rapid improvement in technology and because any information on what the efficiency gains will be have to come from the firm, who could easily lie as there is ​asymmetric information​
● It can also increase dynamic inefficiency as firms are unable to maximise profit so may not invest

Question 10

How is profit regulation used to control monopolies?

(used in the US) - also called rate of return regulation

Answer 10

● The company is allowed to charge prices that cover its operating costs (e.g. wages, fuel, maintenance)
● On top of that, it can earn a ‘fair’ profit, called a ‘rate of return’ on the money it has invested in its capital (e.g. power plants, pipes, etc.).
● This ‘fair’ return is based typical rates of return in a competitive market

e.g If the company spends $1 billion on equipment, and the allowed rate of return is 10%, then it can make $100 million profit per year

Question 11

What are the aims of profit regulation on monopolies?

Answer 11

● It encourages companies to invest in new infrastructure (because they’re guaranteed a fair profit)
● It prevents firms from setting high prices, since profits are capped.

Question 12

What are issues with profit/rate of return regulation on monopolies?

Answer 12

● Gives firms an incentive to ​employ too much capital to increase profits. Firms might also overspend on fancy equipment to raise their allowed profit. This is called “gold-plating”
● Cutting costs will not increase the firm’s profit so there is ​little incentive to be efficient​
● Regulators need sufficient knowledge of the industry and so will suffer from asymmetric information

Question 13

How can quality standards be used to regulate monopolies?

Answer 13

● Monopolists will only produce high quality goods if this is the best way to maximise profits
● The government can introduce quality standards, which will ensure that firms do not exploit their customers by offering poor quality

For example, the Post Office has to deliver letters on a daily basis to all areas and electricity generators are forced to have enough capacity to prevent blackouts.

Question 14

What is a problem with using quality standards to regulate monopolies?

Answer 14

It requires political will and understanding to introduce

Question 15

What are windfall taxes and how can they be used to regulate monopolists?

Answer 15

● These are taxes that are imposed after the event has occured, for example after monopolists have made extremely high profits
● It can discourage monopolists from making excessive profits and/or encourage them to reinvest them

However, it is not a long term solution and firms may begin to underreport their profits

Question 16

How can breaking up a monopolist be used to regulate them?

Answer 16

● The government can split the monopolist up into competing units
● This should lead to lower prices and profits and greater consumer choice

Question 17

What are disadvantages of breaking up monopolists?

Answer 17

● May cause a loss of economies of scale which could even lead to prices rising
● Likely to be little impact from splitting a monopoly up into two firms and lobby groups will make this very hard for the government to do

(lobby groups are organisations that try to influence government decisions, e.g. Greenpeace lobby for stronger climate laws)

Question 18

How can the government promote small businesses to increase competition and contestability?

Answer 18

● Giving training and grants to new entrepreneurs, encouraging small businesses through tax incentives or subsidies. This will increase competition since there will be more firms within the market, and will offer a chance for more firms to join
● It increases innovation and efficiency, since new firms are likely to provide new products and incumbent firms will no longer be able to be X-inefficient.

e.g. - The Red Tape Challenge, schemes, such as the Enterprise Investment Schemes and Seed Enterprise Investment Scheme,

Question 19

What does The Red Tape Challenge do?

Answer 19

Aims to decrease regulation, particularly for small businesses

Question 20

What do schemes such as the Enterprise Investment Schemes and Seed Enterprise Investment Scheme do?

Answer 20

Provide tax relief for people who buy shares in small companies to help them grow.

Question 21

What is deregulation?

Answer 21

The removal of legal barriers to entry to a previously protected market to allow private enterprises to compete

Question 22

How can deregulation promote competition and contestability?

Answer 22

● It will increase efficiency in the market by allowing greater competition as more firms can enter and conduct more activities than they could before
● (The government can also privatise industries, which will allow for competition in the market)

The Deregulation Act of 2015 aims to continue deregulation

Question 23

What are some negative effects of deregulation?

Answer 23

● Licenses for specific industries are necessary to ensure standards are upheld. It can lead to poor business behaviour
● Some have argued that the deregulation of financial markets was a major contributor to the financial crisis in 2008

Question 24

What is competitive tendering?

Answer 24

The process by which public sector organisations invite private firms to bid for a contract to provide a good or service

Question 25

What are private finance initiatives?

Answer 25

PFI - A method of funding public sector projects through the private sector ## Footnote A private company finances, builds, and operates a public facility (e.g. hospitals or schools), and the government repays the private firm over time

Question 26

Are private finance initiatives paid upfront?

Answer 26

No, the government pays back over many years (often 25-30 years) ## Footnote It was used a lot under the UK governments of the 1990s and 2000s

Question 27

How can the government use competitive tendering to introduce competition into a market? What are the benefits of this?

Answer 27

● The government will request competitive tenders by drawing up a specification for the good or service and inviting private firms to bid for the contract to deliver it. The firm offering the lowest price wins the contract, subject to quality guarantees ● This helps to minimise costs for the government and ensures efficiency by allowing for competition in the market. The private sector will have more experience running the projects, so it is likely they will be better managed.

Question 28

What are issues with competitive tendering?

Answer 28

● It may not always be the most cost effective way and the process of collecting bids is costly and time-consuming. ● The private sector may not aim to maximise social welfare in the same way the government would and could use cost-cutting methods that reduce quality

Question 29

How did the Enterprise Act (2002) try to prevent firms undertaking anti-competitive practices such as collusion and predatory pricing?

Answer 29

Meant firms engaging in these practices can be fined up to 10% of worldwide annual sales and those who organise cartels can face up to five years in prison and unlimited fines ## Footnote The problem is that it is very difficult to prove overt collusion and almost impossible to prove tacit collusion

Question 30

Who was fined for breaking the competition act by fixing the price of milk and cheese products?

Answer 30

● In 2011, the 9 supermarkets in the UK were found to be fixing the price of milk and cheese products ● Tesco alone was fined for £10 million.

Question 31

How can the government restrict monopsony power?

Answer 31

● By passing ​anti-monopsony laws ​which make certain practices illegal and can introduce an ​independent regulator ​who will force monopsonists to buy fairly. ● Fines ​can be put in place for those who exploit their power and ​minimum prices may be introduced to ensure suppliers are paid a fair amount ## Footnote Self-regulation can also be used, but this is weak

Question 32

How does the government protect employees with workers rights?

Answer 32

● ​Health and safety laws ● Employment contracts ● Redundancy processes ● Maximum hours at work and ● The right to be in a trade union ## Footnote Can also encourage firms to draw up ​codes of conduct​ relating to employment practice

Question 33

What is the issue with the government making workers' rights too strong?

Answer 33

Employers will be unwilling to take on new workers due to the extra cost of employing these workers

Question 34

What is privatisation?

Answer 34

The sale of government equity in nationalised industries or other firms to private investors ## Footnote The aim is to revitalise inefficient industries but can sometimes lead to higher prices and poor services

Question 35

What is nationalisation?

Answer 35

When a private sector company or industry is brought under state control, to be owned and managed by the government

Question 36

What are the advantages of privatisation?

Answer 36

● Encourages ​greater competition​, which reduces X-inefficiency and ensures low prices and high quality as firms need to be competitive ● Managers become more accountable​, poor performance will mean a fall in share prices and/or shareholders wanting them to be replaced. ● Can ​reduce the public sector net cash requirement (PSNCR) as the sale of shares raises revenue for the government and they no longer have to cover any of the firm’s losses ● Firms can ​invest with greater certainty​, instead of worrying about change when a government is elected every 5 years ● Puts ​utilities into the hands of the people​, since they can own shares. Workers will be more motivated as they know their hard-work will be rewarded by high dividends

Question 37

What are the disadvantages of privatisation?

Answer 37

● When there are natural monopolies it may be fairer for the government to own the firm since they won’t ​abuse their monopoly position​ ● Some argue ​industries such as electricity, water and transport are important ​as they directly affect the success of other industries, so it makes more sense for the government to own them in order to coordinate them properly ● Problems over ​externalities and inequality. ● Some argue it ​negatively affects the PSNCR as firms are under-priced when they are sold and the government no longer receives the firm’s profit

Question 38

What is PSNCR?

Answer 38

● Public sector net cash requirement ● The extent to which government expenditure exceeds government revenue. It is the amount the government needs to borrow to finance a budget deficit ## Footnote (typically an anual figure)

Question 39

What is PSNB?

Answer 39

● Public sector net borrowing ● The amount by which government spending exceeds government revenue in a given time period

Question 40

What are the advantages of nationalisation?

Answer 40

● In the case of a ​natural monopoly​, it is better to be run by the state as they aim to maximise social welfare rather than profit ● The government will ​consider externalities​ ● The government will guarantee a ​minimum level of service for people who suffer the risk of being cut off from the service, due to the lack of potential profit from providing for them ● In a private company investment is only short term as shareholders will see no benefit from long term investment. This may lead to a poor quality of service ● Some say it would be dangerous to let key strategic industries to fall into private hands and could have disastrous effects for the country

Question 41

What are the disadvantages of nationalisation?

Answer 41

● Nationalised industries suffer from the ​principal-agent problem and moral hazard, as managers know that any loss they make will be covered by the government ● They will experience ​X-inefficiency which could cause higher prices for consumers ● They will be ​influenced by government’s decisions and the government may not have enough money to invest

Question 42

What is regulatory capture?

Answer 42

When the regulator acts in the interest of the industry it is supposed to be regulating, rather than in the public interest ## Footnote This is an example of ​government failure​, and argues that government regulation is not the most effective method of achieving competition and efficiency

Question 43

When and why does regulatory capture occur?

Answer 43

● When the regulator is captured by the firm/industry they are regulating. The fact that the regulator will often meet with the firm’s employees will mean they become ​more empathetic, which removes impartiality and weakens their ability to regulate ● Large corporations can ​invest huge amounts in learning how to play the system and in gaining the support of their regulator ● It's also likely the regulator will have worked in the sector for many years, as these people will have experience and knowledge of the industry. As a result, they will have ​personal connections with those that they are regulating, this makes it difficult for them to be unbiased

Question 44

What was the alleged regulatory capture done by Vodafone?

Answer 44

HMRC were alleged captured by Vodafone, and negotiated a tax reduction from £7bn to £1bn in 2009-10​