3.6.1 Government intervention

Question 1

Context - CMA

Answer 1

The Competition and Markets Authority (CMA) 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 2

Government intervention to control mergers

Answer 2

Govt considers whether there will be a substantial lessening of competition (SLC)
- 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 cost.
- 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 3

Govt intervention to control mergers: aim and evaluation

Answer 3

Point: The aim of preventing two large companies merging is so they do not exploit their customers by raising price, offering poorer quality service and reducing choice. It can prevent firms from gaining monopoly power.
Eval: However, very few mergers are investigated each year. The CMA can suffer from regulatory capture (form of government failure when a government agency operates in favour of producers rather than consumers) and may not have all the information necessary to make a decision (imperfect information/asymmetric information/information failure)

Question 4

Govt intervention to control merger: case study

Answer 4

Tesco’s takeover of Booker was allowed as the CMA believed the impact on competition would not be too high since supermarkets are in a hypercompetitive industry. However, the European Commission blocked the merger of Ryanair & Aerlingus in 2010 as they would control more than than 80% of all Europe flights from Ireland.

Question 5

Why monopolies need to be controlled

Answer 5

Holding a dominant position in an industry is not wrong in itself but if the firm exploits this to stifle competition, they are deemed to be anti-competitive. Monopolies are allocative and productively inefficient and so it can be argued that they need to be controlled. Most of this regulation occurs for utilities, which are natural monopolies.

Question 6

Government intervention to control monopolies

Answer 6

1) Price regulation
2) Profit regulation
3) Quality standards
4) Performance targets

Question 7

Price regulation (price capping)

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 e.g. 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

Profit regulation

Answer 8

In the USA, ‘rate of return’ regulation is used where prices are set to allow coverage of operating costs and to earn a ‘fair’ rate of return on capital invested, based on typical rates of return in a competitive market.
- This aims to encourage investment and prevents firms from setting high prices.
EVAL: However, it gives firms an incentive to employ too much capital in order to increase their profits.
It is also criticised since a reduction in costs will not improve the firm’s situation, so there is little incentive to be efficient .
As with ‘RPI-X’ it also means regulators need sufficient knowledge of the industry and so will suffer from asymmetric information.

Question 9

Quality standards

Answer 9

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 e.g. 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.
- Eval: the problem is that it requires political will and understanding to introduce.

Question 10

Performance targets

Answer 10

Regulators can introduce yardstick competition (such as setting punctuality targets for train operating companies based on the best-performing European train operators).
It is also possible to split up a service into regional sectors to compare the performance of one region against another; this is used in the water industry.

Question 11

Government intervention to promote competition and contestability

Answer 11

• Enhancing competition between firms through promotion of a small business
• Deregulation
• Competitive tendering for government contracts
• Privatization

Question 12

Promotion of small business

Answer 12

The government can give training and grants to new entrepreneurs and encourage 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.

Question 13

Promotion of small business example

Answer 13

The Red Tape Challenge aims to decrease regulation, particularly for small businesses. There are also schemes, such as the Enterprise Investment Schemes and Seed Enterprise Investment Scheme, which provide tax relief for people who buy shares in small companies to help them grow.

Question 14

Deregulation

Answer 14

The ​removal of legal barriers to entry to a previously protected market to allow private enterprises to compete. This will ​increase efficiency in the market by allowing greater competition as more firms can enter and conduct more activities than they could before. ​e.g. The Deregulation Act of 2015 aims to continue deregulation.
- The government can also ​privatise industries, which will allow for competition in the market
Eval: It can have some negative effects, leading to ​poor business behaviour​. Licenses for specific industries are necessary to ensure standards are upheld. Some have argued that the deregulation of financial markets was a major contributor to the financial crisis in 2008.

Question 15

Competitive tendering

Answer 15

The government has to provide certain goods and services because they are merit or public goods but this does not mean that the state has to be the producer of all these goods and services. Goods, such as the sheets in NHS hospitals, are ​produced by the private sector and then bought by the public sector.
- A similar thing can be done with services; the government can ​contract out the provision of a good or service to private companies ​e.g. private firms could be employed to run hospitals. These are called ​Private Finance Initiatives (PFI)
Competition can be introduced into the market as 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.
Eval:
However, 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 16

Preventing anti-competitive practices

Answer 16

It is important that they prevent firms undertaking ​anti-competitive practices​, such as collusion and predatory pricing. ​The Enterprise Act (2002) means 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. ​In 2011, the 9 supermarkets in the UK were found to be fixing the price of milk and cheese products and Tesco alone was fined for £10 million. The problem is that it is very difficult to prove overt collusion and almost impossible to prove tacit collusion.

Question 17

Government intervention to protect suppliers and employees

Answer 17

• Restrictions on monopsony power of firms
• Workers rights
• Privatisation and Nationalisation

Question 18

Restrictions on monopsony power

Answer 18

Monopsonists are able to exploit suppliers by reducing prices. The government can prevent these 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. ​Self-regulation can also be used, but this is weak.

Question 19

Workers rights

Answer 19

The government protects employees through ​health and safety laws, employment contracts, redundancy processes, maximum hours at work and the right to be in a trade union. The government can also encourage firms to draw up ​codes of conduct​ relating to employment practice.
Eval: The problem is that if workers’ rights are too strong, employers will be ​unwilling to take on new workers​ due to the extra cost of employing these workers.

Question 20

Privatisation

Answer 20

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

Question 21

Advantages of privatisation

Answer 21

● It encourages ​greater competition​, which reduces X-inefficiency and ensures low prices and high quality as firms realise they need to be competitive.
● Managers become more accountable​, since they know poor performance will mean a fall in share prices and/or shareholders wanting them to be replaced.
● In both the long and short run, it can ​reduce the public sector net cash requirement (PSNCR) as the initial sale of shares raises revenue for the government and they no longer have to cover any of the firm’s losses.
● It ​reduces government interference which some see as a benefit in itself. This also means that firms can ​invest with greater certainty​, instead of worrying about change when a government is elected every 5 years.
● An ideological argument is that it 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 22

Disadvantages of privatisation

Answer 22

● 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 people argue that ​industries such as electricity, water and transport are important ​because they directly affect the success of other industries, and so therefore it makes more sense for the government to own them in order to coordinate them properly.
● There are problems over ​externalities and inequality.
● Some argue that it ​negatively affects that the PSNCR as firms are under-priced
when they are sold and the government no long receives a firm’s profit.

Question 23

Privatisation example

Answer 23

Between 1994 and 1997, the railway industry was privatised. This has seen a rise in passenger satisfaction and a growth in investment. Season tickets have risen with inflation but standard single fairs have risen by 200%.

Question 24

Nationalisation

Answer 24

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

Question 25

Advantages of nationalisation

Answer 25

● Investment is needed for the long term​, but 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.
● In the case of a ​natural monopoly​, it is better for monopoly to be run by the state as they aim to maximise social welfare rather than a private business who will maximise profits.
● 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.
● Some say it would be dangerous to allow key strategic industries to fall into private
hands as this could have disastrous effects for the country.

Question 26

Disadvantages of nationalisation

Answer 26

● 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 and this could cause higher prices for consumers, especially since the industry will become a monopoly.
● They will be ​influenced by government’s decisions and the government may not have enough money to invest.

Question 27

Nationalisation examples

Answer 27

Post WWII brought high levels of nationalisation and this is known as the ‘golden age, a period of high growth before a period of stagflation that led to privatisation of these same industries. It became apparent that they suffered from high losses and were X-inefficient.
The NHS is a nationalised industry which suffers from a lack of funding and a lack of competition, both of which lead to poor quality. They also suffer from uncertainty as spending on the NHS changes every five years with the new government; this causes problems and is something Jeremy Hunt has tried to change.

Question 28

Natural monopoly

Answer 28

As the name implies, a natural monopoly exists naturally. Market forces allow one player in the market to become the only player in a certain industry without stifling the competition. Regular monopolies, on the other hand, are created when a company controls the market by eliminating the competition.
E.g. oil, gas, electricity, water, railways, telecom companies

Question 29

Natural monopolies and nationalisation

Answer 29

Natural monopolies bring about the question of nationalisation. It is argued that if the industry is likely to end up as a monopoly it is better for the consumer if that monopoly is controlled by the government, who will maximise welfare.