Government and Business – Policies, Market failures 7th of April

Key issues Market Failure Public Goods Externalities Competition policy; Policies towards research and development; Training policies; Environmental policy; Transport policy; Privatisation.

Market Failure Market Failure – “A condition that arises when unrestrained operations in the markets yield socially undesirable outcomes” What do governments do to prevent market failure? Establishing and Enforcing the Rules of the game Market efficiency depends on people using your resources to maximize your utility. Promoting Competition Preventing firms from colluding. Regulating Natural Monopolies Natural monopolies – when one first serves the market at a lower cost than other firms. (and charges a higher price than socially optimal) Providing Public Goods

What is a Public Good A public good is a good that is non-rival and non excludable. Non-Rival – Means consumption of the good by one person does not reduce the availability of the good for others. Non Excludable – means that no one can effectively be excluded from using the product Examples: Air, Mp3 Songs, Youtube Taxes are used to pay for public goods! Excludable Non-Excludable Rivalries Private goods – Food, Clothing Cars Common Goods – Fish Stocks, timber Non-Rivalries Club Goods – Cinema, Private parks, satellite television Public goods – National TV, Defense

Externalities Dealing with Externalities Externality – a cost or benefit that falls on a third party and therefore ignored by the two parties to the market transaction. Negative externalities - pollution Positive externalities – beautification of the neighborhood Market prices do not reflect externalities Governments use the items below to discourage negative externalities and promote positive positions Taxes Subsidies Regulations

Competition Policy Classical economic theories assume that markets are efficient and that a market system enables competition and innovation Classical and neo-classical economists believed on the limiting roles of Government In practice, markets may not operate efficiently and governments extensively regulate markets to encourage competition

Competitive policy Do you think that market power is always ‘a bad thing’? Producer viewpoint - make supernormal profit, but how large this can be! even with Monopolist can still charge a lower price due to economics of scale more R&D Consumer viewpoint Government concern is that whether the ‘market power’ goes against the public interest

Competitive policy Three possible targets of competitive policy Monopoly policy – the abuse of the existing power of monopolies and oligopolies Merger policy – the growth of power through mergers and acquisition Restrictive practices policy – oligopolistic collusion

Policies towards Research and Development Technology policy Technology policy involves government initiatives to affect the process and rate of technological change and its rate of adoption Targets of technology policy Invention – new ideas, new products Innovation – new ideas are implemented in practice Diffusion – new technology spreads throughout the economy

Policies towards Research and Development Technological change and market failure R&D free riders – property right can protect this monopoly power – monopoly may not conduct R&D in the presence of high market power Duplication – resources may be wasted in duplicating research risk and uncertainty – payoffs from R&D are so uncertain

Research and development by sector Source: Based on data from 2011 EU Industrial R&D Investment Scorecard, (European Commission)

R&D intensity Source: Based on data from Eurostat, Science and Technology Database, (European Commission) 12

Policies towards Research and Development Forms of intervention the patent system public provision R&TD subsidies co-operative R&D diffusion policies other policies

Policies towards Training Training and economic performance labour productivity productivity gap between countries partly depends on differences in skills innovation and change importance of adaptability and skills of the workforce costs of production skills shortages create labour bottlenecks and increase production costs

Policies towards Training Training policy approaches to training policy encouraging workers to stay with their employer subsidies for training industry-wide training programmes by firms publicly provided training partnerships between government and firms

Environmental Policy Pollution could be classified as a ‘negative externality’ of production and consumption Production – marginal social costs (MSC) are greater than the marginal private cost to the polluter No charge on the producer for use of air and rivers means that environment is a free good – encourage overuse This is role of the Governments to ensure minimum environmental quality

Global CO2 emissions, 1900 to 2010 Source: Carbon Dioxide Information Analysis Centre (2012) http://cdiac.ornl.gov/

Environmental Policy Environmental policy options market-based policy: market-based policies attempt to internalise the cost of externality, and ensure that the polluter pays. Indirect taxes on specific types of polluting activity , such as green tax Tax should be equal to marginal external cost to achieve a socially efficient output

Environmental Policy Problems with using taxes difficulty in identifying socially efficient tax rate problems with demand inelasticity redistributive effects problems with international trade effects on employment uses of green taxes in various countries

Environmental Policy Non-market-based policy: Command – and- control (CAC) systems: The use of laws or regulations backed up by inspections and penalties for non-compliance approaches to devising CAC systems technology-based standards – based on best available pollution control strategy ambient-based standards - based on minimum standards for the environment social-impact standards – focuses on the effects on people (e.g., health or happiness)

Transport Policy Traffic congestion is a challenge for all nations adds costs and stress of modern living The allocation of road space demand for road space a derived demand – to get to the destination determinants of demand – price, maintenance cost, income etc. the price and income elasticities of demand Price of substitutes/complements Complementary service, e.g., parking 2

Increase in car ownership in various European countries Cars per thousand population Source: based on data in Energy and Transport in Figures (EC, 2009)

Transport Policy Policy 1: direct provision the road solution - more roads public transport Policy 2: regulation and legislation restricting car access bus and cycle lanes no entry to side streets pedestrian-only areas parking restrictions 4

Transport Policy Policy 3: changing market signals extending existing taxes road pricing variable tolls area changes / supplementary licences electronic road pricing experience of London and Singapore subsidising alternative means of transport 5

Privatization Privatization is the process of transferring owner of a business, enterprise, agency or public service from the public sector to the private sector Pros Performance Increased Efficiency Specialization Less Political interference Less corruption Accountability Profit motivation Cons Profit may not be the motive Capital Strategic and sensitive areas (defense) Essential services Job loss