Why is it so difficult to implement the deregulation needed to make an economy more competitive? Why do so many governments try to achieve this end, and why do almost all of them fail? All citizens stand to benefit from competitive markets for products and services, but more often than not, the broad coalition required to sustain pro-competitive policies never materializes -- political support simply isn't there. Why?
This question is important not only in transition economies and other emerging market countries, but in rich countries as well -- in fact almost everywhere, except possibly the US and the UK, which long ago embarked on a process of radical and far-reaching economic liberalization. New Zealand and Ireland followed suit and their economies have been booming ever since.
Lack of competition is typically due to over-regulation. Taxicabs in European cities are expensive because the number of licenses is strictly controlled. With market entry blocked, license owners face little pressure to hold down fares, and the officials who allocate licenses are well placed to collect votes or bribes. In short, regulation tends to distort incentives, stimulating what economists call rent-seeking behavior -- the taxi driver and the license official collect unearned premiums (rents) solely because they can exploit their position as insiders, not because they are more productive.
Notaries are another example of this phenomenon. Public notaries in many countries charge extremely high fees for services that are virtually useless. Fees are high because the notaries themselves control access to their profession. Without government regulation (including rules requiring that consumers purchase their useless services), public notaries would not have the position from which they draw rents.
Examples of the benefits of deregulation abound. The taxi market in Ireland is deregulated, and fares there are cheap. For some time after US airlines were deregulated, the five-hour flight from New York to Los Angeles cost much less than the half-hour trip from Zurich to Frankfurt. Similar discrepancies were found in the price of a coast-to-coast phone call in the US and that of a domestic long-distance call in France.
Whereas regulation creates unearned rents for overprotected minorities (taxi drivers, notaries, airline pilots, and telecom or electricity workers), deregulation reduces these rents and redistributes them to the general public. But because overprotected minorities enjoy privileged access to politicians, it is no surprise that deregulation incites so much fierce -- and effective--opposition.
Public utilities are a good example of this. Whenever a government attempts to liberalize the electricity industry, unions and firms join forces in opposition. Workers and management oppose deregulation because openness to competition would eliminate their unearned premiums. The wages of electrical workers are high precisely because they have appropriated a part of the rents created in an uncompetitive electricity market.
Is there a way to weaken this opposition? What if a government, instead of fighting the electricity industry alone, unleashed an economic "big bang," trying to liberalize most markets at once?
An analogous "all or nothing" procedure was used in the US in the 1980s to close unneeded military bases. Since 1945, there had not been a single base closure. Even though the Pentagon itself wanted to close many of them and use the money elsewhere, no measure could be gotten through the Congress, because military bases qualify as "pork" -- the favors for their constituents that help congressmen get re-elected -- and, according to old and sacred informal rules, no congressman will ever vote against pork in a colleague's district. But a plan to close numerous bases passed by an overwhelming majority when the congressional leadership finally agreed to present a single list of bases to be closed; the list could only be voted up or down, without any possibility of amendments. Good sense triumphed over pork.
The cause of economic liberalization would be greatly advanced by adopting similar strategies. For example, electricity workers would realize that, as consumers, their gains from lower prices throughout the economy more than compensate them for the loss of rents in their own firms. The big bang approach gives workers a stake in liberalization and thus makes deregulation politically easier to pursue.
Deregulating product markets has an additional benefit -- it facilitates liberalization of the labor market. Evidence gathered by the OECD shows a strong positive correlation across countries between the degree of competition in the product market and the extent to which labor market regulations increase the powers of workers when they bargain with firms. Bargaining is mostly about the distribution of excess rents between the firm and its workers. In a competitive industry, where there are no excess rents, there is little to bargain about.
In some cases, however, regulation works in the opposite direction -- it keeps the price of public services artificially low, rather than too high. This is true of railway fares throughout continental Europe, which are subsidized by government. Here again, winning the battle for deregulation requires convincing consumers that they stand to benefit. Railway fares will be higher, but taxes will be lower, because only those who actually use trains will pay the costs, rather than the non-traveling taxpayers. Deregulations of airlines and bus transportation will also create healthy competition for railroads and help keep prices from rising too far.
Piecemeal deregulation is doomed to fail. Generating sufficient political support to enact reforms that can survive the opposition of vested interests requires attempting to deregulate the entire economy simultaneously, not select industries, one by one. The key to eliminating inefficient, unproductive subsidies to minorities is to implement tax reductions for all.
Alberto Alesina is professor of economics at Harvard University and Francesco Giavazzi is professor of economics at Bocconi University, Milan.
Copyright: Project Syndicate
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