Commercial and Political Efficiency Lecture Notes, Part Two January 28, 2004

Three types of efficiency Managerial efficiency: Efficiency in the provision of services Political efficiency: the efficiency in the provision of political services When is a Crown or mixed enterprise superior to alternative policy instruments such as subsidies, tax expenditures, regulation of or direct expenditure in pursuing a goal Market efficiency: the absence of monopolistic behaviour

Factors Contributing to the Efficient Provision of Commercial Services The main difficulty is that managerial utility comes at the expense of the value of the firm Efficient resource use is sacrificed at the expense of managerial perks. Net agency costs = value of the firm less the value of the managers perks Four forces work to minimise net agency costs internal monitoring the market for managers product market capital market

Factors Contributing to Efficient Provision of Commercial Services by Government Enterprises Ownership of government enterprise is not transferable is the major difference There can be no market for corporate control Dispute resolution is carried out via a political process Those who object to an investment decision by a Crown cannot sell out to those who favour it. The voice option and not the exit option is the only one open. Politicians have the incentive to enforce managerial efficiency on behalf of the tax payer-owners of the Public Enterprise PE is the best of all possible worlds, combining the risk-reducing benefits of widely dispersed ownership with the detailed oversight of managerial performance

Incentives for Politicians No interest in allowing subordinates to consume resources which they could used for their own purposes Disposition of potential surpluses will occur at the political level and not the managerial level. However, how will the politicians dispose of the Crown Corporations surplus? Will it be spent in the manner desired by the electorate or will it be consumed by politicians. The double agency problem now emerges: The management of PEs must act as the government wishes, and the governments must act as the electorate wishes.

Incentives for Politicians If the political market is efficient, then a strictly commercial public enterprise will be indistinguishable from a commercial private enterprise. Two contending positions concerning the commercial operations of PEs: one: the discipline of capital markets on managerial behaviour two: the respective disciplinary role of product markets competition and internal monitoring by politicians.

Efficiency in the provision of Political Services: Commercial or Crown Governments can purchase political services from firms induce them to engage in activities which they would not undertake without government inducement. ie. the use of less productive inputs or less productive combinations of inputs, or the location of activities in a less productive location than the firm would otherwise choose. Direct subsidies for grain shipment Subsides to use certain groups of individuals drawn from disadvantaged groups The location of activities in remote or otherwise high- cost location

Efficiency in the provision of Political Services: Commercial or Crown The creation of regulation, which includes cross- subsidisation The firm providing the public service is a crown corporation Government may purchase a political service from a Crown by means of direct subsidies, as it does in the case of grain. Government can use regulation to give a Crown a monopoly which are then provided to the provision of a political service Government may provide neither subsidies nor use a monopoly, but accept a low or zero rate of return on its equity for the provision of a political service. Eg. SEDCO and SOCO Two dimensions of the choice: What is the nature of the political services to be performed? Are the criteria for acceptable performance clear?

Two Factors If the measurement of costs and performance is costly and the transaction cannot be disciplined by the ability of either party to turn elsewhere, the Crown or government department will be preferred to the private firm as an agent? How important is the political service to the total activities of the agent? The more important the political service the more likely the reliance on Crown Corporations and ultimately on a government departments.

Economic Efficiency and Political Expediency Governments have a number of means for altering market outcomes: Direct taxation, regulations, etc It can: assume the existence of a desired amount of redistributive activity and then investigate the lowest cost means of redistribution. assume that the desired amount of redistribution is itself a function of the means available to effect it. The value of using Crown corporations is: They facilitate redistribution in that the loser are less aware of the magnitude of the their losses and are therefore less inclined to oppose the transfer, while the beneficiaries remain fully aware of there gains They can deliver a political service not because it can do it at the lowest cost, but because the redistribution involved would be discerned and successfully opposed if any other mechanism were chosen

Economic Efficiency and Political Expediency A government enterprise may facilitate transfers by reducing the incentive of the victims of these transfers to oppose them. The losers in income redistribution are less likely to opposed it the more costly it is to determine the amount they will lose and the less each individual looses. Government enterprise may facilitate redistribution by obscuring its magnitude from the losers, by spreading its burden on a groups whose opposition will not take the form of withdrawal of political support (Infra-marginal voters.) There is some reason to argue that the facilitation of a transfer is not socially beneficial if it is a measure that society would not acquiesce to were it better understood (that is attempted by more direct means)

Conclusion There is some consensus that government and private enterprises in mature industries do not differ appreciably with respect to commercial efficiency. The implication is that given the market environment, a great burst of productivity cannot be expected from the privatization of provincial telecommunications companies. There is also some evidence that government enterprise is ill suited to participate successfully in entrepreneurial businesses. Mixed enterprise provide the worst of all possible worlds. It does not combine the benefits of transferable ownership with efficient provision of political services.