Article by Jeffrey L. Harrison
Government sponsored attempts to encourage optimal resource allocation in those cases in which the market system is either particularly slow to operate or completely ineffective has taken a number of forms. When the problem is one of insufficient competition, the antitrust laws are available to insure that businesses will exhibit the type of independent self-interest essential for approaching competitive equilibrium. In other cases, particularly those in which a natural monopoly has existed or may continue to exist, government activity has taken the form of direct price regulation. The goal in these instances is to permit the utilization of available economies of scale while preventing exploitative pricing.
The results of government activity in these areas has been far from encouraging. Studies in the antitrust field have led to serious questions concerning the allocation of scarce enforcement resources. There is equally convincing evidence that much direct regulation is of questionable utility. Typical questions raised by critics of existing regulatory schemes include whether regulated rates are in fact lower than those which would exist in an unregulated market, whether regulation is, in the long run, beneficial to consumers, and whether the rationales for regulation in particular cases were or continue to be valid.
The discouraging results of present attempts to either encourage increased competition or regulate monopoly power justify a search for an alternative. With this goal in mind, it seems appropriate to once again consider reliance on a form of government competition generally labeled "yardstick competition." While the yardstick concept has been employed in a number of contexts, its most important test to date was surely its role in the Tennessee Valley Authority. Since that time the concept has largely fallen from sight and has been relegated to concluding chapters or short sections in textbooks in the areas of regulatory institutions or economics. It is quite possible that the dismissal of the yardstick was the result of expectations that were far too rigid. Given the current problems of economic regulation, it appears the question of the theoretical precision of yardstick competition should be subordinated to the question of how the effectiveness of an imprecise form of yardstick competition compares with that of existing regulatory schemes.
An assessment of yardstick competition and development of a theory of "workable" yardstick competition require a review of past yardstick and yardsticklike experiences as well as a discussion of the shortcomings of the concept. The following materials are devoted to these tasks. First, however, it is necessary to define the limits of the yardstick concept. Yardstick competition may take one of three forms. The government entity may own and operate an enterprise that is not in direct competition with private firms but that provides a standard by which regulatory agencies may evaluate the prices and performances of privately owned firms. In this form the government enterprise constitutes a source of data for the currently existing regulatory scheme. This has been labeled the "naive" yardstick, largely as a result of the difficulty in finding production and marketing circumstances similar enough to allow direct cost comparisons. In the concept's second form, the yardstick firm is in direct competition with the privately owned firm or firms. The objective is to increase the difficulties of even tacit collusion in hopes that prices will tend toward competitive levels. Here, direct regulation and antitrust enforcement may be supplemented or replaced by competitive market forces. Finally, the specter of government competition may serve as a form of potential competition that has the effect of discouraging private firms from utilizing their market power to full advantage.
It is important to distinguish the use of yardstick competition from government activities designed to correct the problem of suboptimal production in the case of goods involving social spillovers. The spillover problem is usually alleviated by some form of subsidization that lowers the private costs of production. In contrast, use of the yardstick involves the implicit recognition that a competitively determined price covering the full costs of production is consistent with a socially desirable level of output. Thus, a public sector competitor selling at prices that do not reflect the total costs of production to a private producer is not engaging in yardstick competition. A typical example would be one in which the capital of the public sector competitor is obtained through appropriations. In the absence of the requirement that a return be paid to those who have contributed capital, or at least the requirement that an interest equivalency charge be made, the public supplier is hardly competing on a cost parity basis. Even in those cases in which capital is generated primarily through debt financing, the government firm receives subsidizationlike aid through the nontaxable status of the interest paid to bondholders and the resultant lower interest rate that the government borrower is able to pay. While these enterprises are certainly involved in government competition, they can hardly be labeled yardstick competitors. The importance of this is clear when one realizes private sector firms must, even in very competitive industries, earn what economists call a "normal" profit in order to compensate investors. Any government competitor that does not adjust its price to allow for this distinction should, in the long run, force private competitors from the market. This, of course, is inconsistent with the role of yardstick competition, which is to prod private enterprise, not replace it.
The theory of yardstick competition is rather easy to present and understand. As is so frequent, however, there is a distinct tension between theoretical precision and practicality. In reality, it is extremely difficult, if not impossible, to achieve cost parity. The discussion of the Tennessee Valley Authority, which follows, focuses on this problem. A far more important question is whether the goals of prodding private enterprise without preempting it can be achieved without theoretical precision. It is to the concept of imprecise but "workable" yardstick competition that the concluding materials of this article are devoted.
About the Author
Jeffrey L. Harrison. Associate Professor of Law, The University of Houston. B.S. 1967, M.B.A. 1968, Ph.D. 1970, University of Florida; J.D. 1977, University of North Carolina.
Citation
53 Tul. L. Rev. 465 (1979)