Why the UK government regulates firms and markets.

University Degree Business and Administrative studies

Word Count: 1430

With the use of examples and economic theory, explain why governments regulate firms and markets.

The western world is often viewed as one built on the ideal economic principle of a free market, this is one where supply and demand, rather then any influencing force, dictates the success of those participating companies within it.

The reality within the UK economy is not one of complete free competition but is in fact a mixed economy. Though far from being a command economy the UK government has regulated and controlled the market conditions to some degree in all industries. This is most apparent within the laws contained within the Competition Act 1998 which stipulates that any one organisation that distorts, restricts or prevents competition shall be liable to imposed fines either through government bodies or individuals seeking compensation through the courts. (OPSI, Date Unknown)

The question of the principles to why the Government regulates firms and markets is complex. This essay seeks an answer, using economic theory and the example of the UK’s telecommunications market, the rationale for Government involvement.

Baldwin and Cave (1999) identified that regulation can be categorised into three separate formations; 'a set of commands or rules applied by body set up for the purpose', a 'deliberate state influence incorporating all forms of state influences on business and social behaviour' or 'all forms of social control of influence.' In the telecommunications industry you can see all of these three types of regulation; however, the first is the most prevalent within the telecommunications market.

The UK telecommunications market was solely, apart from a small district within the area of Hull, provided by the post office and then when separated British Telecommunications (BT) until 1981 when Mercury Telecommunications was established. This was later followed in 1984 by the privatisation of BT, the UK government held a 49.8% remaining share of BT, which has subsequently also been sold (Parker, 2004).

BT’s privatisation lead to the creation of the Office of Telecommunications otherwise known as OFTEL, an official office of the UK government’s civil service, subsequently combined with the regulator for broadcasting to create the Office of Communications in 2003, otherwise known as OFCOM. OFCOM is responsible for regulating and providing licenses to all telecommunication providers. The ultimate penalty for not complying with OFCOM guidance can be the removal of the licence of these companies to operate (OFCOM 2003).

Its statutory duties are set down in the Communications Act 2003, the act stipulates OFCOM’s responsibilities are “to further the ...

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Its statutory duties are set down in the Communications Act 2003, the act stipulates OFCOM’s responsibilities are “to further the interests of citizens in relation to communications matters; and to further the interests of consumers in relevant markets, where appropriate by promoting competition” (OPSI, Date Unknown).

To complete these responsibilities OFCOM has the power to intervene where there is a specific statutory duty to work towards a public policy goal which markets alone cannot achieve. They claim to operate with a bias against intervention, but with a willingness to intervene firmly, promptly and effectively where required. OFCOM seek the least intrusive regulatory mechanisms to achieve its policy objectives. (OFCOM, 2003). These powers include being able to set pricing and the commercial terms of companies products which have significant market power and ensure all market entrants have access to the necessary infrastructure and technology to provide equivalent services.

The reasoning for the UK Government’s decision to regulate the telecommunications market on the privatisation of BT is clear as when entering this newly formed competitive market place BT had a near monopolistic position. In 1981 BT held nearly 100% of the telecommunications retail market in the UK; as of 2008 this stood at 66% of residential access and 57% of business access. (OFCOM, 2008)

At the time of having a monopoly BT were making supernormal profits for the services that they were providing, due to this the market place was attractive, however, the barriers to entry of this market place were significant due to the capital costs associated with telecommunication infrastructure. The cost of production of an equivalent service would have meant building a telecommunications infrastructure similar to BT’s own, currently valued at £19 billion, (BT, 2008)

Without OFTEL allowing potential BT competition regulated access to the national telecommunications infrastructure owned by BT the set up costs associated with competing in this market place would have been prohibitive. The access to the national telecommunications infrastructure to date is still regulated. The service and costs are standardised across the market place, resulting in all parties having equivalent cost to market and access to means of production. (Parker, 2004)

The resultant effect of this cost regulation by OFTEL encouraged entrants by allowing in first instance supernormal profits and after a time reducing these to a level just above normal profit. This meant entrance into this market place was initially attractive to new competition and ongoing a viable industry. Further to this above OFTEL ensured the behaviours of BT and new entrants was restricted. Being in a position of market dominance BT could have operated in several ways to ensure retention of their market share and prohibit penetration by their competitors in the market place.

Firstly BT or a large new entrant could have instigated predatory pricing. In most general terms predatory pricing is defined in economic terms as a price reduction that is

profitable only because of the added market power the predator gains from eliminating, disciplining or otherwise inhibiting the competitive conduct of a rival or potential rival.(Bolton,2000). For example France Telecom set broadband prices in France artificially at a low level to maintain their market share within. (Reuters 2007).

Secondly BT or a large new entrant could have instigated product tying; In his 2000 research paper A, Pieter describes tying as when a firm engages in tying when it makes the sale of one of its products conditional on the purchase of one of their other products. For example Microsoft’s operating systems and web browsers being integral to one another. (Fisher, 2001).

Thirdly over capacity in the market place may have occurred, this is where previously state owned enterprise declines and new private enterprises pursuing market share flood the market, resulting in drastic fall in price, which fuels smaller or inefficient companies into bankruptcy or exit from the market. (Rieti, 2006) .

The Government’s regulation of the market place has ensured that none of the above has ensued within the telecommunications market place.

The present market provides a choice of suppliers, levels of services and a reduction in the cost to the end customer. Without this degree of intervention within the market place by the Government through OFTEL and then OFCOM this would have only been possible through individual organisation bringing action under the Competition Act 2006 themselves if anti competitive behaviour was demonstrated which is a costly exercise.

Without the ability of other operators to enter the market place through regulation this position would have not been meet. At the present levels BT's 2008 market share still represents a significant dominant market position and hence the continued regulatory control by OFCOM.

In conclusion the Government’s regulation in the case of BT and other previously nationalised industries is necessary due to the monopolistic position of the open market place upon its creation.

The principle of a free market place is compromised by the intervention of Government bodies regulating it, however, is it not just where the government is culpable for a skewed monopolistic position to begin with?

A free market where supply and demand sets the level of competition within a market place rarely exists. In this particular extreme of previously nationalised industry heavy regulation is required to ensure a healthy level of competition and a rebalance of the market to a fair position.

The rationale for Government regulation in may cases is therefore to assist in realigning these markets to artificially create a fairer economic position for existing and potentially new entrants where previous Government intervention has restricted a free market.

References.

Fisher, 2001, Franklin M. and Rubinfeld, Daniel L.,United States v. Microsoft: An Economic Analysis. Antitrust Bulletin, 2001. Available at SSRN: www.ssrn.com/abstract=247520 or DOI: 10.2139/ssrn.247520

OFCOM ,2008, Fixed Narrowband Retail Service Market Review, retrieved online at on 29/03/09

Bolton, Patrick, Joseph Brodley, and Michael Riordan, 2000, “Predatory Pricing: Strategic Theory and Legal Policy”, Georgetown Law Journal, 88, August 2000, 2239- 2312.

VanderWerf, Pieter A. 2000, "Product tying and innovation in U.S. wire preparation equipment," Research Policy 19: 83-96.

Baldwin, R., Cave, M.,1999, ‘Understanding Regulation: Theory, Strategy, and Practice’, 1st Edt., Oxford University Press, 1999

OPSI, Date Unknown, Competition Act !998, retrieved online at on 30/03/09

Parker, D, 2004, 'The UK's privatisation experiment', Journal, February 2004 retrieved online at on 27/3/09

BT, 2008, Annual report 2008, retrieved online at on 29/03/09.

OPSI, Date unknown, Communications act 2003, retrieved online at on 29/03/09