Economy-wide Consequences of Regulatory Reform in an Australian Context

This paper examines the economy-wide consequences of regulatory reform, with particular focus on price-cap regulation and competition regulation in Australia’s services industries. A general equilibrium model is used where oligopolistic firms produce differentiated products and interact on prices with tacit collusion represented by conjectural variations parameters. When capital stocks are fixed in the short-run, the effects of price-cap regulation prove to be unambiguously expansionary. Taken alone, price-cap regulation reduces the domestic price of the service, benefiting households and other industries that use the service as an intermediate input. The economy gains from the associated improvement in allocative efficiency. In the long-term, with both intersectoral and international capital mobility, pricecap regulation can be either expansionary or contractionary depending on the specific characteristics of the services industry being regulated. Competition regulation is modelled as a reduction in the level of tacit collusion between firms within a services industry, reflected by a change in conjectural variations parameters. One finding that emerges is the equivalence of competition regulation and price-cap regulation in the short-term and long-term while ever the number of firms in an industry is fixed. Allowing free-entry and exit leads to substantial structural change in regulated services industries following competition reform. The exit of firms allows the remaining firms to produce further down their average cost curves yielding net gains economy-wide. When there is entry of firms however a trade-off is observed between the benefits of productive efficiency and the duplication of fixed costs. These tradeoffs are quantified in the context of Australian services industries, including Electricity, Transport and Water. Surprisingly, competition reform in Telecommunications leads to adverse economy-wide effects which stand in contrast to the results of competition regulation in all the other services industries modelled. * This paper has been prepared for the National Honours Colloquium in Economics, 20 August 2004, University of New South Wales