competition and government 1 chapter 7 prof. dr. yeşim kuştepeli eco 4113 fiscal economics

COMPETITION AND GOVERNMENT

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CHAPTER 7

Prof. Dr. Yeşim Kuştepeli ECO 4113 Fiscal Economics

Competition and Government

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Competition is central to the workings of a market system.

Government’s role regarding competition takes many forms: - actions to encourage or costraint competition- competition between governments- competition among private firms in supplying products and services to the government as a buyer, - frequent cases when both government and private producers are supplying similar services to overlapping clients.


Encouraging Competition3

Governments have two primary tools to promote competition and restrain the excesses of monopoly.

* Antitrust law is a tool, which defines and imposes penalties for behavior by firms that is intended to limit or destroy competition.

* The other tool is a variety of regulatory agencies to curb the excesses of monopolies that are not within the reach of the antitrust laws. Historically, these regulated monopolies have included telecommunications, banking, railroads, trucking, airlines, and electric power providers.


Workable Competition4

There is usually enough workable competition. The competitors who generate workable competition may be firms in related industries or workable competition may come about as the result of new technology.

In either case, its main feature is to offer consumers some alternative suppliers or products in order to restrain most of the excesses of what generally proves to be only monopoly power.


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Regulatory agencies tend to develop cozy relationships over time with the industries that they regulate, thwarting the intent of oversight.

As a result, the capture theory of regulation says that these agencies will come to regulate their industries largely for the benefit of the industries themselves rather than their customers, who are underrepresented in the regulatory process.


Workable Competition

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In recent decades, more emphasis has been placed on positive approaches to encouraging competition.

Some of these approaches includeFacilitating technology tansfer (from universities

and government laboratories)Small business developmentBusiness incubatorsPooled risk managementOther services that enable new firms to get a

start against established competition Prof. Dr. Yeşim Kuştepeli ECO 4113 Fiscal Economics

Workable Competition

Discouraging Competition7

People who invest in physical or human capital can establish their property rights to earn a fair rate of return.

For people who invest in intellectual or artistic creations, protecting property rights is a major challenge.

Governments offer creators of such valuable products and services some degree of protection through Patents, Trademarks, Copyrights.


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These allow the creator to sue those who copy or appropriate their work without permission to earn a return on their investment.

They also create some degree of monopoly power for their owners.

To avoid long term monopolies, these intellectual property rights have finite lifetimes.

Every government has to weigh the trade-offs between ensuring that people have incentive to invent, innovate, and create and the risk of encouraging small, inefficient, unresponsive monopolies.


Discouraging Competition

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A second effect that government has, indirectly, on competition in the private sector is through its procurement practices.

Government purchasing favors large firms.

Because the paperwork is complex, the volume of the order is often very large.

Larger firms are more connected to the information network through which information about planned government purchases is disseminated.



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A third, indirect but significant effect that government has on competition has to do with the paperwork burden that firms incur in complying with a host of regulations,s uch as environmental,d isability access, gender equity, and worker safety rules.

As the compliance costs will raise the average or unit cost more for a small firm than a large one, regulations have the effect of putting small firms at a competitive disadvantage.



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Finally, governments have been the sole supplier of certain kinds of services because the market is limited and the economies of scale is substantial that only one firm-or none-could serve the market.

Public transportation, rural electricity, solid waste collection and disposal have been in government hands because the alternative is either a private monopoly or no supplier at all-services considered desirable as merit goods or goods with positive externalities but unable to generate a profit as an inducement for a private supplier.



Competition Between Government and Private Firms

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One of the defining characteristics of government is that it possesses certain kind of monopoly power.

At a minimum, governments have a monopoly on the lawful use of force, reserved to the police.

Thus, the government is able to compel citizens to submit to its demands.

Those demands include payment of taxes, compliance with the speed limit, registering for the military draft, attending school until age 16, and smoking only in designated places.


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When a government has the exclusive right to provide services, it can’t force people to use its services but it can prevent others from supplying similar services.

As a result it will be less sensitive to customer concerns and less likely to try to be more efficient, to keep prices down, and to provide better services.

In many areas, government agencies compete both directly and indirectly with private firms, both for profit and nonprofit.



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Direct competition takes place when certain services, such as education, transportation, health care, are offered by both public and private agencies.

Indirect competition means that many government activities could be undertaken by private suppliers, in which case the threat of lost jobs, loss of power and prestige can have the same effect as direct competition on bureaucrats and government workers.

Threat of competition forces government to be more efficient, accountable if they think that service provision might be turned over to a private supplier.



Should government compete?15

When government is expected to compete directly with private suppliers of some services (e.g. education), what happens to social benefits or public goods aspects of the service that justified public involvement in the first place?

While government agencies and business firms have some common challenges, methods, characteristics, they are quite different in mission and purpose.

The similarities and differences will vary greatly from one agency to another. The appropriate standards for evaluating their performance may be very different.


Competing in the labor market

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Private firms and governments at all levels compete in the labor market for the same pool of available workers.

The package offered to laborers by government tends to be different. The wage scale is less attractive, but there is much more job security, more opportunity for advancement, more generous benefits, particularly sick leave and annual leave.

Private firms vary greatly, but they tend to rely heavily on salary as an incentive rather than job security or benefits.


Competition for resources within government

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All government agencies have to compete for resources.

Because government, like households and firms, faces a budget constraint.

The budget constraint is strongest for local governments,who usually must balance their budgets and have limited ability to raise taxes or find new revenue sources.


Fiscal surplus, fiscal impact, economic impact

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Fiscal surplus: the cost-benefit calculations made by the industry, potential resident or commercial developer in terms of taxes, fees, and public services.

Fiscal impact: the opposite side of the coin, looking at taxes and fees generated and public services demanded from the governments’ point of view.

Economic impact : the brodest of the three measures, looking at the total change in economic activity in terms of income, employment, and wealth creation.


Fiscal surplus or deficit19

Add up the value of services received and subtract the value of taxes paid (including any fees or other nontax obligations).

If the difference is positive, the tax payer has a fiscal surplus; if negative a fiscal deficit.

While taxes are easy to measure, the value of services received is highly subjective, so that two taxpayers with the same tax burden may have different fiscal surpluses because they value services differently.


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Mathematically, the fiscal surplus for the ith individual in the jth location is given by

FSij = ΣSVij-ΣTij

whereFS: fiscal surplus SV: the value of services received from governmentsT: taxes, including fees and other forms of nontax obligations


Fiscal surplus or deficit

Fiscal impact21

The government compares the cost of providing services for the additional resident to the amount of revenue that resident would be expected to generate.

If the new resident will generate more revenue to government than the cost of providing the additional services, the fiscal impact is positive.

The mathematical formula is

(SC):FIij= Σ Tij –ΣSCij

where FI: fiscal impact, SC: the estimated additional service costs


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The revenue side is the easier part of the computation.

The cost of serving an additional household may vary according to size, income, location.

Determination of fiscal surplus and fiscal impact is not a zero-sum game, although there are some trade-offs.

If the value citizens place on the service is higher than the cost of producing it, citizens have a fiscal surplus even while local government has a positive fiscal impact.


Fiscal impact

In the case of a pure public good, where adding another user does not diminish the amount available to existing users, the service cost of an extra resident is zero while the value of the service remains positive.

The government can afford to offer this taxpayer a favorable tax service package because an extra resident will result in a revenue increase, yet expenditures will remain unchanged.

Fiscal impact


Economic impact24

Economic impact measures not only the effect on/of the public sector but also the impact on the private economy from adding new firms or residents.

The key to creating a positive economic impact is some external source of private revenue, which may come from selling goods and services to non residents or from attracting residents that have a source of income from outside the local economy.


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Export industries (local firms sell to buyers outside the local market) have multiplier effects on the local economy in terms of the additional spending and job creation.

Communities need export industries to acquire the resources to pay for imports.

A manufacturing industry is one way to have that multiplier effect, as well as medical centers, resource based industries (agriculture, oil, minerals) or a “mailbox economy” of retirees receiving pensions and Social Security checks from elsewhere.


Economic impact

Interstate competition,tax/service incentives

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States (cities) are in competition with one another for industry and high income residents.

Every state would like to attract or develop high-quality employers who pay good wages, pay lots of taxes, demand few services, respect the environment, and enhance the quality of life in the state.

To create positive fiscal impacts, states must lure the residents and firms with both special amenities and tax/service packages that are competitive with other locations.


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To balance a positive fiscal impact with a positive fiscal surplus, states turn to negotiated agreements with business firms.

While many firms build large plants with a long useful life, others require little capital investment and can easily relocate.

Therefore, local governments iclude a provision called clawback which requires repayment of certain benefits if the firm doesn’t stay in that location for some minimum period or fulfill the terms of the aggrement in terms of cash invested and jobs created.


Interstate competition,tax/service incentives

Interlocal competition, the Tiebout hypothesis

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Even more intense than the competition between states for residents and industry is the competition between local governments for high-income residents, commercial facilities of various kinds, industry, and even state institutions (colleges, prisons,hospitals).

Making those choices, moving between localities because of the relative attractiveness of the tax and service packages, is called “voting with one’s feet”.


Tiebout hypothesis29

The classical description of the workings of interlocal competition was that of regional economist Charles Tiebout in 1956.

The Tiebout Hypothesis has been one of the most fruitful ideas in regional economics because it has led to considerable empirical testing as well as further refinements of understanding of locational decisions and capitalization of the fiscal surplus into the prices of land and homes.


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The Tiebout Hypothesis was based on the assumption that workers and firms not only engage in the informed, self-interested decision-making processes, but also workers and firms are mobile.

Communities, in turn, are trying to attain some optimal population in order to reach an efficient size that will minimize the average cost of providing public services.

Under these circumstances, people will tend to cluster in communities in which tastes and preferences for public services and taxes are relatively homogeneous.


Tiebout hypothesis

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This model suggests a monopolistically competitive model of many similar communities differentiated by the offerings of the public sector as well as other amenities that influence people’s locational choices.

The Tiebout hypothesis suggests that mobility gives voters much more voice and clout in the decisions of the local public sector.

The threat of losing residents or industrial facilities because of mobility is a powerful device for getting the attention of politicians and bureaucrats.


Tiebout hypothesis

Homogeneous communities32

The Tiebout hypothesis suggests that market-type forces will result in communities that are relatively homogeneous in terms of preferences for public services and the willingness to pay for them.

One conclusion of the Tiebout hypothesis is that there may be some tendency for communities to become segregated by income levels.


Fiscal capitalization33

The process by which present and future fiscal surpluses are reflected in the prices of houses is called fiscal capitalization.

Capitalization refers to the process by which a stream of future income flows or expected costs is incorporated into the present value of an asset.

If the fiscal surplus on a property increases, the value of the property should increase by the same amount.


Fiscal capitalization34

If the fiscal surplus decreases, either because the expected future tax burden increases or the expected value of services decreases the value of the property should decline.

The change in the stream of future obligations and benefits is incorporated into the value of the property, or capitalized.

An important implication of fiscal capitalization is that any changes in taxes or service levels impact primarily those who own the property at the time, not future owners.


Fiscal zoning35

Another implication of the Tiebout hypothesis is that cities can attempt to defend themselves against citizen mobility through zoning to limit in-migration of low-tax, high service demand residents.

When zoning regulations set high minimum lot sizes or square footage requirements in order to protect the value of the fiscal surplus of established and higher income residents, they are engaging in fiscal zoning.

Fiscal zoning tends to create homogeneous communities not only in tastes and preferences but also in income and wealth.


International competition and government

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In a global economy, national governments are in competition with other nations and this puts constraints on their monopoly power.

If the factors of production did not move, the only source of competition between national governments would be movement of goods, which governments could restrict with tariffs, quotas, other regulations.


International competition and government

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If a single government loses much of its monopoly power, it can regain or retain power by joining with other nations to become one of oligopolists or “price leaders”.

Large nations or coalitions of nations have considerable influence in international negotiations on such issues as working conditions, environmental regulations, and protection of intellectual property rights.


competition and government 1 chapter 7 prof. dr. yeşim kuştepeli eco 4113 fiscal economics

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