Price and Productivity Change Following Deregulation: The US Experience

Abstract

No real world market is likely to be perfectly contestable, anymore than it is to be perfectly competitive. Yet, like its predecessor, the contestability benchmark proves highly useful as a framework for evaluating policies and outcomes. Under the contestability framework, entry and price regulation is deemed inappropriate in industries which do not have system-wide natural monopoly characteristics. On this criterion, brokerage, airline, trucking, long-distance telephone and terminal equipment should not be regulated. True, these industries may be characterised by some elements of scale economy, such as economies of vehicle size, so that at some level (city-pair routes) only a few firms may serve. But industry performance need not suffer in such an unregulated environment. Impediments to entry and exit, not concentration or scale of operations, may be the primary source of prices that are not welfare optimal. Even in the presence of natural monopoly characteristics, it is important to isolate those markets which are not yet structurally competitive, as in the case of coal shipments over which the railroads are judged to possess 'market dominance' or in local telephone service. It can be argued that the latter should continue to be overseen by regulators while markets which are controlled by competitive forces, deriving from actual or potential competition or taking other indirect but effective forms, should be free from traditional regulation. Thus, unlike privatisation policy in the United Kingdom, described in the companion article by Kay and Thompson (I985), US deregulatory policy can be construed as having a coherent rationale. The nature and extent of deregulation match remarkably well with the policy prescription of the theory. This paper analyses the consequences that have emerged under deregulation in terms of the following behavioural properties predicted by multi-product competition and contestability theory: a variety of products will emerge, each of which will yield zero economic profit; the revenues from any subset of the products must exceed the incremental costs of those products, so that no cross-subsidy can exist; prices for each product will equal or exceed marginal costs; and an equilibrium market structure will minimise costs for the industry (see Baumol