Privatization, Regulation and Deregulation

Michael Beesley

• Publisher: Routledge
• Year: 2013
• Print ISBN: 9780415164535
• eBook ISBN: 9781134711581
• Topic: Business
• Subtopic: Business generale
• Index: Business

In this second edition of Privatization, Regulation and Deregulation, the author has updated and augmented the original material to take account of developments over the last 5 years. This volume includes ten completely new chapters and coverage of the critical period from 1981to the present. The book provides a unique insight into the privatization and regulatory procedure. In addition, it presents a significant contribution to the basic economic arguments underlying these reforms to practitioners involved in privatization and regulation.

1

Introduction

M.E.Beesley

FORMATIVE INFLUENCES

The essays in this collection represent ten years’ involvement in privatization and regulatory affairs. They appear at a time when, having become London Business School’s first emeritus professor, reflections on one’s early formative influences are expected. A previous collection of essays—on urban policy—was published in the early 1970s. Those essays reflected my preference for market-oriented solutions to policy issues, but in truth I had little hope of their being influential. At that time no one could have foreseen the political changes which were to promote markets to a central place in economic policies. The changes were particularly welcome to me.

Arguments in favour of free markets were implanted in my undergraduate days at Birmingham from 1942 to 1945, by Arthur Shenfield’s unfailingly brilliant defence of the competitive paradigm. He had plenty of opportunity to show its very wide application, as in those wartime years he had perforce to shoulder much of the economics teaching. He, in turn, had been much influenced by Hayek and others at LSE. So we undergraduates were immediately in the thick of the problem of the legitimate scope of the state in economic affairs. And the debate was a serious one: leading up to the 1945 election there really was a choice for or against a massive increase in state control. In that election, I well recall arguing vehemently that what was wrong with the coal industry, for example, was the lack of competition, not too much. Both Tory ideas of centralized control of the pre-war coal cartels and the Labour idea of nationalization were equally wrong. Later, in 1950, I was an unsuccessful Liberal candidate, but gave up active campaigning after that. For me, 1950 was the last occasion on which that party could truly claim to be intellectually descended from Gladstonian liberalism. From my viewpoint, politics had then deteriorated into an unedifying competition to manage a corporate state, leaving free-market ideas to live on in such stalwarts as Ralph Harris and Arthur Seldon of the IEA.

But I also had a highly practical interest in industry. I had originally embarked on a B.Com. degree because of a youthful ambition to succeed in business. Many years before, there had been a small but prosperous family concern which my grandfather had sold. It was clearly a matter of regret to my father that he had not been taken into it, an elder brother having thoroughly disillusioned my grandfather by having a good time in the USA instead of negotiating useful printing rights. To run one’s own firm, I thought, was the way to get the profits; to be an executive like my father was insufficient.

As a practical training for business, Birmingham turned out to be something of a disappointment. The Faculty of Commerce had failed to develop along the lines foreseen by the founding spirits, among them Sir William Ashley and Joseph Chamberlain, whose support for Birmingham’s aspirations was contingent on creating such a faculty. Before 1914 it had a good claim to be effectively the first UK business school. Between the wars it had become a fairly conventional economic and social sciences school. It still had. however, a commitment to learning about, and observing, industry. Here, P.Sargant Florence, lecturing from what appeared to be a compost heap of notes, provided a sharp contrast to Arthur Shenfield, who prided himself on never bringing as much as a single sheet to class. But Florence convinced me of the need to supplement economic insight with the careful development and interpretation of data. More important, it became clear that immersing oneself in the facts was often a useful method of developing new questions for analysis.

These intellectual influences were to surface in academic work later. Graduating, I duly followed the course I had mapped for myself. Rejecting the offer to stay on for a Ph.D., I and my father found a firm of metal workers located in the old jewellery quarter in Hockley, Birmingham. They did not want the small capital I was able to offer, but the three directors had no children to follow and so wanted an assistant with a view to succession. The firm, Henry Jenkins and Sons Limited, quoted on the Birmingham Stock Exchange, boasted an issued share capital of £16,666.13s.4d. (This odd figure, so tradition had it, was the result of an unwise speculation in stamping medals in the Boer War. In those days, adversity had to be met head on. Henry Jenkins and Sons had been incorporated at £50,000.)

To my dismay, I discovered that business, in 1945/6, was not a chance to deploy economics for strategic reasoning in the interests of the firm. It was, rather, a matter of progress chasing, of attempting to keep output up by whatever means came to hand. It had some instructive lessons in rationing, of which we were both the victims and the perpetrators. But intellectual starvation played a large part in persuading me to return to the university after 15 months to take up the Ph.D. offer.

Nevertheless, the experience left an indelible mark. For one thing, the firm itself had practically every known kind of non-ferrous metal forming and shaping, and had never, it seemed, quite abandoned any process in its long history. For example, we occasionally used an oval turning lathe to form the edges of blanks for silver-plated platters. Curiosity led me one day to scrape its stock. The date 1825 appeared. Thus began a practical scepticism for accounting valuations. I was also given a task deemed appropriate for a fresh graduate, namely job costing and pricing. I would meticulously weigh and measure, time and enquire, producing what were by common consent far more accurate job costs than ever before seen in the firm. On receiving one, the managing director would say ‘Very good, Beesley. Now, we don’t want that one. Add 100 per cent.’ To the next he would say ‘This is important, add 25 per cent.’ These sessions caused me to reflect deeply on the nature of accuracy in costing: but I soon realized what my essential function was—to save him from making too low a quotation. He obviously had a keen appreciation of what each ‘market’ would bear.

He also had a favourite maxim: ‘There are three good livings in this business, my boy. It’s our job to protect them.’ Coupling this with latter-day sophistication in pricing theory, one might well describe his policy as a kind of private sector application of Ramsey pricing, where the ‘good livings’ and plant overheads represented the required gross profit constraint. But because of material shortages, and rationing, this would perhaps be to express the short-run view. Everyone looked forward to the return of pre-war days of opportunity, when, especially on Saturday mornings when cheap return rail fares were to be had from London, people with ideas for new products would canvass the Birmingham ‘metal bashers’ for production and backing. At all events the experience was enough to make me most sceptical when back at university of the notion, widely held in the late 1940s, and often revived since, that it was not sensible to assume profit maximization as a working hypothesis in analysis. However rough and ready, here was a practical demonstration of preferring more profit to less, with a clear, if intuitive, appreciation of elasticity in demand and avoidable costs.

The jewellery quarter was also a living monument to R.H.Coase’s view of the firm. Firms’ boundaries were indeed manifestly driven by trading off the advantages of arm’s length dealing against the advantages of administrative relations. Not only did the quarter’s firms embrace every imaginable constellation of integration, Henry Jenkins and Sons itself had one operation within its walls—metal spinning—in which the head spinner recruited and paid his own labour whilst working with Henry Jenkins’s machines and materials, for a negotiated price. Thus was nurtured a scepticism about issues of the ‘benefits’ of firm scale and, in particular, about the immutability of integration and of labour contracts.

Back at university, I embarked on a Ph.D. suitable for one convinced that what was then principally needed in government-industry relations was an effective anti-trust law and not the other modes of government interventions then beginning to proliferate. I wanted to study cartel (trade association) activity and perhaps work out effective countermeasures. This was hardly in the spirit of the times. I well recall Mrs Joan Robinson earnestly advising me against pursuing the topic, chiefly on the grounds, it appeared, that all that could usefully be said on the topic of collusion had already come to light in the Robinson-Chamberlin debate on imperfect or monopolistic competition. I always had some difficulty in connecting these views with her appearance as one of the first members of the newly formed Monopoly and Restrictive Practices Commission. Indeed the Commission itself seemed to me an aberration for a Labour government, until I later read the parliamentary debate leading up to its formation. From this, it seems likely that establishing the Commission was a reward to the Co-operative allies of Labour, then numerically important, who had suffered considerable disadvantages at the hands of trade associations. Many of these regarded cooperatives as vehicles for undercutting fixed retail prices and many organized refusals to supply them. Collective resale price maintenance duly occupied much of the early years of the Commission.

Despite the heavyweight advice, I persisted for some time with the Ph.D. topic. I had one big stroke of luck. A university friend’s father happened to be an enthusiast for ‘orderly marketing’, involving alliances between manufacturers and distributors. He was the chief executive of a large Birmingham non-ferrous concern. He thought he could correct my misguided references to ‘collusion’ etc., by showing me what really happened in these associations. So he invited me to read the series of minutes, from their foundations, of about eight manufacturing associations in different products his firm made. I was spellbound. I had heard that Birmingham businessmen were often valued according to their success in organizing associations. Here the skills were revealed. In association A, on Monday, he or his representative (depending on whether ‘trouble’ was expected or not) might, for example, throw his weight behind arguments to form a ‘fighting fund’ to discourage newcomers. On Tuesday, in association B, he might be earnestly resisting the idea of agreements on advertising outlays. On Wednesday, he might be resisting the notion that, since association C had been so beneficial to members up to now, it would be useful, henceforth, for members to bring new products to the meeting for approval. On Thursday, in association D, he might be agreeing to develop more information to enforce the association’s price agreements.

These histories were illuminating in several ways. One’s economic training had stressed the industry as the unit of interest. What I had found ran counter to the idea, then quite prevalent, that there was in a given group of firms forming an association an inevitable progression to complete collusion. Here was a warning that one must consider individual firms’ interests and limitations to understand collusive behaviour. More important, it suggested that a more interesting focus for enquiry might be the firm, in its several manifestations, rather than the industry. In each product there was an optimum scope for association activity, depending on its value to the company. Unfortunately, when I showed no sign of embracing the collectivist faith the facility was withdrawn, and with it any hope of getting permission to publish any analysis of the phenomena. However, it did greatly influence my teaching of ‘industrial organization’ later, in the 1950s. When I occasionally meet students who sat in those classes, if they remember anything of what they were taught, it is always my accounts of how to manage collusion in the Birmingham brass trades!

Not progressing as I had hoped, I left Ph.D. studies for a spell in regional town and country planning with the West Midlands and North Staffordshire Plans. These were the heady days of physical planning, when economists in all seriousness were asked to predict, as in my case, how the future development of the motor car industry would affect town development in the West Midlands and North Staffordshire. I soon discovered that ‘planning’ did not mean, as I rather thought it would, combining different disciplines to arrive at a larger, more satisfactory, model. At the time, I thought that others’ refusal to take on board economists’ reasoning was some failure of the intellect. With hindsight, I realized that the function of economists was essentially to provide the men in charge—in that case the eminent architects Sir Patrick Abercrombie and Herbert Jackson—with some reassurance that their vision of interdependent urban and rural physical development would not be undermined by adverse economic change. On a somewhat grander scale, this resembled the function my costings had provided for Henry Jenkins’s managing director in his pursuit of good business.

Perhaps the most important by-product of that experience for me was access to the individual data on plants, from the Factory Inspectorate, which I saw could form the basis for a greatly revised Ph.D., and which enabled me to finish it by 1951, the Plans having been completed in 1949. The Ph.D. was on Interlocking Directors. The question was, what influence, if any, would be made to computations of concentration in industries if, instead of taking ownership as the basis for control, one took common boardroom membership? I still think this an interesting notion and I duly found that it did make a lot of difference to computed concentration, depending on the industry and the directness of the interlocking (for instance, what if firm A was interlocked to firm B indirectly through firm C?). I have to admit that much as the measurement of concentration has developed, and despite the fact that questions about its limitations are still standard fodder for examination questions, ownership stubbornly remains the underlying criterion of control in such studies. But more baffling at the time was how to interpret the phenomenon of interlocking directly. By collating board memberships of the companies in what amounted to a census of plants in West Midlands metal industries, I had come up with the result that at least one-third of all activity was interlocked, at least at some remove.

Colleagues at Birmingham were equally baffled, but respectful of what had obviously been a gruelling job. (No computer aids in those days. Collation had to be done laboriously, by clipping cards and using needles to shake out possible interlocks.) My own interpretation was not particularly strong. Clearly it was quite implausible to suggest that this was a web of active control mechanisms. It was far too diverse, and I remembered the behaviour of the large Birmingham brass-founder. I thought that the probable significance was essentially as a risk-reducing device. When substantial investment was mooted by an individual firm, the network was used to signal intentions, mark territories, and learn of possible conflicts. The important learning for me lay in the fact that I found propositions about the theory of the firm in a comparative static framework simply inadequate to grapple with the problem. My interpretation, tentative as it was, meant that I had to consider the origins of change in the conditions facing firms. I also had to understand better the idea of ‘power’, which I thought best approached in a negative way, as the relative absence of constraints (a ‘near’ interlock was more influential than a distant, indirect one).

As a result of my Ph.D., I was offered, and accepted, a lectureship in commerce, eventually inheriting, in 1955, Sargant Florence’s responsibility for lectures on industry. This was during what its members now think of as the great age of Birmingham’s Faculty of Commerce and Social Science. Alan Walters gives its flavour in his essay on ‘The life philosophy of eminent economists’. With Terence Gorman, Frank Hahn, Alan Walters himself, and Esra Bennathan it was a powerhouse for economic thought. It also boasted sociologists and social psychologists, especially Chelly Halsey and Josephine Klein, well able to stand up for themselves in debate. We took the Faculty’s business traditions seriously. For example, in a cross-disciplinary group, we turned our attention to the mysteries of decision making, by taking it in turns to present papers. Esra Bennathan summed up the proceedings succinctly when he said on one occasion ‘at least we have learned that decisions are the by-product of hysteria’. We concluded, wisely, that we should each concentrate on his or her own relative advantage. It was not the first, but also not the last, occasion on which the limitations of interdisciplinary discussion in social science were exposed.

For me, the most difficult question of this period was how to reconcile the obviously powerful competitive paradigm, as presented in an increasingly well-thought-out neo-classical framework, with Schumpeter’s persuasive criticisms in Capital, Socialism and Democracy. His characterization of capitalism as driven by incentives of creating monopoly, but subject to the perennial gale of competition, rang very true when I first read the book as an undergraduate, and it was probably the beginning of an active curiosity about how to analyse firm behaviour. The subsequent experiences in business, recounted earlier, and a continuing interchange with businessmen did nothing to dim Schumpeter’s appeal: on the contrary. Specifically, it offered an explanation for the existence of profits as an outcome of innovation: that is new products, services and production methods. The ‘perennial gale’ ensures that the profits, to use the neoclassical term, would become a quasi-rent stream, not a permanent rent.

I do not think that anyone has since improved on Schumpeter’s account of the source of profits. It certainly seemed to me a great improvement on the utter shiftiness involved in using the idea of ‘normal’ profits, which rather mysteriously were supposed to keep neo-classical firms’ noses to the grindstone. Yet at the same time, like nearly everyone else, I had to accept the logic and the usefulness of the idea of resource allocation for which the idea of the firm in neoclassical economics had been invented. As I shall recount below, I now think I have come to terms with, and find useful, both modes of thought. But it took many more years to do so.

The mark of a ‘coming’ economist in the 1950s was that he or she would receive an invitation to visit, and usually teach for a year in, a well-known American university department. One by one, my promising Birmingham colleagues duly did so. I got mine, at last, in 1959. Through Gilbert Walker’s good offices, I was invited to the Wharton School in Philadelphia, to be an associate professor for a year. It was duly a watershed. More than that, it introduced me to the fully professional business school; and Gilbert asked me while in the United States to make the rounds of other eminent schools, as far west as Chicago, to advise on what Birmingham’s developments should be. When I got back, I advised that it was necessary to concentrate on postgraduate education, not undergraduate, and to have a two-year M.B.A or equivalent as the academic backbone, but that it was also necessary to generate a lot of shorter courses (of much less intrinsic academic merit) to make financing...

Table of contents

• Cover
• Halftitle
• Title
• Copyright
• Dedication
• Contents
• List of figures
• List of tables
• Acknowledgements
• General note
• 1 Introduction and postscript
• 2 Privatization: principles, problems and priorities
• 3 Privatization: reflections on UK experience
• 4 The regulation of privatized monopolies in the United Kingdom
• 5 Mergers and water regulation
• 6 The required rate of return/cost of capital
• 7 The DGWS in operation
• 8 Competition and supply in London taxis
• 9 Information for regulating: the case of taxis
• 10 Bus deregulation
• 11 Collusion, predation and merger in the UK bus industry
• 12 Commitment, sunk costs, and entry to the airline industry: reflections on experience
• 13 UK experience with freight and passenger regulation
• 14 Liberalization of the use of British Telecomunications’ network
• 15 The British Telecom/Mercury interconnect determination: an exposition and commentary
• 16 The liberalization of telephone services in the UK
• 17 Price regulation and competition
• 18 The conditions for effective utility regulation
• 19 RPI—X principles and their application to gas
• 20 Mergers and economic welfare
• 21 Abuse of monopoly power
• 22 Media concentration and diversity
• 23 Schumpeter and UK pharmaceuticals
• Name index
• Subject index