Wednesday, June 03, 2009

The competition solution

One of the best books I read on economic policy in the past 5 years was The Competition Solution: The Bipartisan Secret Behind American Prosperity. The author, economist Paul A. London, appears to be as bipartisan as the title of his book, having served in the Clinton Administration and as a fellow at the conservative American Enterprise Institute.

As the description on amazon says:
The Competition Solution contrasts the vibrant, competition-driven American economy of the 1990s with the oligopolistic, inflation-prone one of the 1970s. London uses anecdotes and examples to show how both Republicans and Democrats helped bring down the oligopolies and monopolies by backing open trade, supporting antitrust, and ending price fixing in key industries.

He tells the story of how the courts and politicians helped competitors challenge the Big Three auto companies and the United Auto Workers; Big Steel and the steelworkers union; airlines and their unions; AT&T and the Communications Workers of America; the trucking companies and the Teamsters; the established eastern financial institutions; and even powerful local retailing interests. Our future prosperity, London argues, will require political leaders who are willing to take on these kinds of fights.
It's true that in the late 1970s and early 80s that the effort towards privatization and less government was largely bipartisan. One of the biggest advocates for deregulation and the expansion of competition was President Jimmy Carter, who helped push through the deregulation of the trucking and airline industries (with an assist in the latter from Sen. Ted Kennedy of all people). In a column in today's Wall Street Journal, meanwhile, Holman W. Jenkins lauds Carter for his introduction of competitive forces into the railroad freight industry.

The logic behind the push for competition is simple: competition makes everything better. It makes quality go up and costs go down. In contrast monopolies are synonymous with sloth, poor quality and high prices. The key to a dynamic and productive economy, therefore, is high levels of competition.

I thought about all of this when I read a post on the Economix blog today about monopolies in Mexico:
When Nafta took effect on Jan. 1, 1994, there was optimism in Mexico that the free trade accord, along with a raft of other market-based measures, would usher in growth and chip away at the country’s social inequalities. That never happened. Average annual growth in the 15 years of the North American Free Trade Agreement has been about 3 percent.

What went wrong with those forecasts? For several years now, economists and policy-makers inside and outside the country have been trying to puzzle that out. Now the World Bank has published a book, “No Growth without Equity?,” that summarizes the theories explaining Mexico’s mediocre performance. The book argues that special interest groups, particularly in business and labor, have managed to block changes that would make the economy more efficient and productive in an attempt to preserve privileges built up over decades under Mexico’s closed economy and one-party state. Most important, those groups have frustrated attempts to introduce competition.

...Among the book’s cases studies are two areas where Mexico is falling behind by just about any measure: its state-owned oil monopoly, Pemex; and telecommunications, where one player, Teléfonos de México, is so dominant that it exercises a de facto monopoly. [Telmex is controlled by Mexican billionaire Carlos Slim, a creditor and shareholder of The New York Times Company.]
These are two very interesting examples. Mexico, like many other countries, has a state-owned oil company that was put in place to guard against natural endowments such as oil falling into the hands of foreigners. I am not at all exaggerating, with Pemex established under article 27 of the constitution and efforts to privatize the company seen as a violation of this document.

As a government entity Pemex has incentive neither to maximize profits or customer satisfaction. Instead it is part jobs bank, part piggy bank, with its revenues used to provide jobs to Mexicans and fund the federal budget. With $173 billion in revenue the company has over 138,000 employees on its payroll while ExxonMobil, with $477 billion in revenue, has just under 80,000 employees.

Wikipedia illustrates the absurdity of how the company is run:
Despite its current $77 billion in revenue, PEMEX pays high taxes that contribute a large portion of the budget of the federal government. In recent years the company has only been able to make ends meet through massive borrowing, so that it now owes a staggering $42.5 billion, including $24 billion in off-balance-sheet debt because the Mexican government treats the company as a major source of revenue. The state-run company pays out over 60% of its revenue in royalties and taxes, and those funds pay for two fifths of the federal government's budget.

In 2005, with record-breaking oil prices, the company has seen an unexpected excess of funds. This trend continued in 2006, but these funds have been used to pay salaries of bureaucrats and current costs, instead of being invested in projects of exploration and production; during the President Fox administration, these funds represent around 70 billion dollars, yet the administration says there is not enough money to pay the debts. The lack of investments prevent adequate refining capacity to be added. While exporting crude oil, Mexico imports expensive gasoline.
In other words, Mexico's great gift of oil actually serves to make it poorer, with Mexicans paying more for gasoline than should otherwise be the case. Perhaps worse for the country, the company is treated like a giant slush fund, allowing politicians to engage in patronism and promoting corruption.

The other example is Telefonos de Mexico -- Telmex. As the economix blog details:
The book’s discussion of Mexico’s telecommunications industry chronicles a series of regulatory decisions since Telmex was privatized in 1990 that have barely curbed its quasi-monopoly power.

Rafael del Villar, a former official in the communications and transport ministry who recently was named to Mexico’s Federal Telecommunications Commission, or Cofetel, writes that Telmex has successfully fought antitrust regulators in court. At the same time, Cofetel has effectively allowed Telmex to keep prices high and throw up obstacles that keep potential competitors at bay.

“Telmex has exercised its substantial market power unchecked,” he concludes.

Roger G. Noll, an economics professor at Stanford, argues that the end result is that Mexico’s telecommunications industry has not developed fast enough. The proof is that fewer Mexicans have access to fixed lines or Internet than residents in countries with a similar level of income.

Although the figures date back to 2005, more recent statistics show that Mexico’s comparative position has not improved much. For example, in broadband Internet access, Mexico is squarely at the bottom of the rankings of member countries of the Organization for Economic Cooperation and Development.
Unsurprising behavior -- and results -- from a monopolist. To promote a better economy, promote more competition and reduce barriers to entering the marketplace. Also remember that as we pile on the rules and add new regulation that we move in the opposite direction, raising new barriers to entry and stifling competition -- a key reason why big business often has no problem with big government.


cvcoss said...

It's good to note that Mexico is taking some steps (albeit small ones) to change this structure. Back in October the Chamber of Deputies approved amendments to Mexico's Energy Reform laws, and though these are not at the constitutional level opening the sector for private investment, it does authorize private companies to provide goods & services to PEMEX and other state-owned companies. This reform basically confers greater autonomy to PEMEX's administration/ops, making it more closely resemble private companies' decision-making authority

Colin said...

Interesting, thanks for the update.