The Implications of Economies of Scale, Scope and Network Integrity on the Privatisation of Transport Services
Seminar Paper 1998 19 Pages
Since the privatisation and deregulation of domestic transport markets, the involved industries have witnessed major changes in their structural organisation. In general it could be observed that the average firm size as well as industry concentration have increased considerably. Bankruptcies, mergers and takeovers are common place in those transport industries (Oum and Zhang 1997). Whether the driving force behind the firms becoming larger is an evidence for the existence of economies of scale, or the sole motivation can be found in gaining market power has very important implications for competition policy planning and implementation.
Policy-makers appear to believe that in such deregulated environments a larger company size may have advantages in productive efficiency (Oum and Zhang 1997). The objective of this paper is to explore the implications of the development of scale economies to service integrity economies for the economic perception of market structure. The new insight into the existence of natural monopolies bears important lessons for decision making process concerned with privatisation in the transport industry.
2. MARKET STRUCTURE AND NATURAL MONOPOLY
As mentioned above already, the interest of analysing returns to scale, scope or service integrity lies in the fact that they indicate the existence of a natural monopoly. Availability of such information is important to the policy-maker to devise effective regulatory or antitrust measures, which guarantee an efficient market structure and maximum (constrained) social welfare after privatisation. Therefore this section is devoted to very briefly outline the basics of market structure and natural monopoly.
The two extreme cases of market structure are the ‘naturally competitive’ market, where a large number of small operators have reached a competitive equilibrium, and a ‘natural monopoly’, where it is always cheaper for a single firm to produce the relevant output than for two or more firms to produce it. A case in between is a ‘natural oligopoly’ wherein a small number of efficient firms will fit into the market (Keeler 1997). A natural monopoly exists if either economies of scale, economies of scope or economies of service integrity can be found (Hensher 1993). In the economic sense a competitive market can or will provide an economically efficient solution. For these markets deregulation is the appropriate means of privatisation. A natural monopoly requires intervention or regulation, unless there is competition ‘for the market’. In this case the threat of market entry will discipline the monopolist in terms of costs minimisation, price control, however, is shown to be necessary. Otherwise the monopolist will be able to earn above-normal profits. If there is no competition for the market regulation also need to control production efficiency. Such above-normal profits are not compatible with governments’ objective of maximising the welfare of the community.
3. FROM ECONOMIES OF SCALE TO SERVICE INTEGRITY
The concepts of economies to scale through to economies of network integrity basically indicate that a single firm can supply output(s) more efficiently than two or more firms are able to due to varying factors of production (see table 1, next page). The discussion of the development of those factors used in economic analysis to determine the existence of a natural monopoly is the scope of this section.
Table 1. The concepts of economies of scale, scope and service integrity