Performance Measurement, Regulation and UK Productivity A Multidisciplinary Overview of

1. Performance Measurement, Regulation and UK Productivity A Multidisciplinary Overview of Unintended and Indirect Effects Ideas factory Presentation, 10 July 2006 Gerben Bakker, Stavroula Iliopoulou, Joseph Antony, Vlado Balaz, Anjula Gurtoo, Rosalind Rae, Kim Tan, Kathryn Walsh, and Alan Williams Essex-Leeds-Nottingham-Loughborough-Exeter

2. Structure • Focus • Key characteristics • Background • Theoretical perspectives • Potential outputs • The future • Conclusion

3. Focus: • Regulation and performance measurement • Indirect, unforeseen and unintended effects • On UK productivity • Comparison with other countries • Overview of literature • Overview of existing seminal cases • Detailed examination of a few cases in detail

4. Key characteristics: • Multidisciplinary • Emphasis on the practical • Specific cases as focal points

5. Why is this research worthwhile? • Regulation and performance measurement critical for understanding productivity performance • At present literature is compartmentalised by discipline • Collaborative, blue skies research • In the spirit of the Ideas Factory

6. Background: • Low-budget £50,000 multidisciplinary scoping study • 5 investigators, each in a different discipline (pro bono) • 5 Research Officers • Experimental character (content as well as process)

7. Structure of project: • Two wide literature and conceptual studies • Economic and business literature on indirect effects of regulation • Literature on indirect effects of performance measurement (and potential relation to regulation)

8. Structure of project: • Three case-studies, each across a different empirical dimension • A specific type of regulation (environmental) • A specific industry (engineering) • A specific regulatory event (air line deregulation)

9. Theories on regulation • Normative analysis as a positive theory (NAPT) • Capture theory (CT) • The economic theory of regulation (ET)

10. Normative analysis as a positive theory • Market failure • Natural monopoly • Externalities • Problems • Assumes market failure rather than test it • No evidence, or contrary evidence • Limited effect of regulation on monopoly pricing

11. Capture theory (CT) • Industry captures the regulatory process so that regulation favours the existing industry • Problems: • Assumes capture rather than test it • Contrary evidence

12. The economic theory of regulation (ET) • Regulation as the outcome of competition between interest groups that all want to maximise their income • Two major models/approaches: • Stigler/Peltzman model: regulator maximises political support • Becker model: the relative effects of competing interest groups

13. The economic theory of regulation (ET) • Benefits small groups with strong preferences • Regulatory outcomes are generally not profit-maximising because of the constraining effects of consumer groups • Regulation most likely in: • Competitive industries • Monopolistic industries • Market failure makes regulation more likely

14. Effects of regulation and the role of time • Immediate (=direct) effects: • Static efficiency • Allocative • Productive • Long-run (=indirect) effects: • Dynamic efficiency

15. Regulation potentially competitive markets • Competitive model • First-best effects • Second-best effects • Imperfectly competitive model

16. Direct effects: the competitive model • First-best effects: • Welfare loss per definition • (price different from marginal cost) • Minimum efficient scale of firms

17. Direct effects: the competitive model • First-best effects (continued): • Effect 1: classic deadweight consumer loss • Effect 2: inefficient market structure • Average costs per firm higher • Entry prohibition limits welfare loss • Reduction no. of firms may reduce it further

18. Direct effects: the competitive model • Second-best effects: • Theory of second-best • Spread of regulation does not reduce welfare necessarily • Unregulated firms can undercut regulated ones • E.g. trucks vs. railroads

19. Direct effects: imperfectly competitive model • Firms restrict supply to keep price > marginal costs • Regulation to reduce price may increase welfare • Free entry can lead to too much firms (inefficiency) • Effects of entry/exit regulation unclear • Practical problem: • Difficult to know right costs and prices (information; asymmetry)

20. Indirect effects: price and entry regulation • P > MC, entry prohibited • Effect 1: excessive non-price competition • Quality (e.g. warranty, advertising, characteristics, R&SD, service) • Dependent on: • Available technology for differentiating products • Ease of collusion

21. Indirect effects: price and entry regulation • Effect 2: productive inefficiency: • Workers extract rents  K/L higher than optimal (substitution) • Inefficient firms are not replaced by entrants

22. Indirect effects: price and exit regulation • p < MC; exit prohibited • Effect 1: cross-subsidization • E.g. telephone, post, airlines • Effect 2: reduced capital formation • Higher r because of higher risk

23. Dynamic effects • The effects so far were in a static situation • Dynamic (long-run) effects can be considered indirect per definition • They mainly concern the incentive to invest in R&D/innovations

24. Dynamic effects • Regulation  entry   innovation  • Price  p > MC  too much R&D  p < MC  too little R&D • non-price competition   R&D, adv.  • Regulatory lags • Innovation  • But staged (slower) adoption of innovations

25. Dynamic effects • Effect of regulation on productivity growth can be substantial: • In US 12 – 21 percent of productivity slowdown during 1973-1977 can be attributed to regulation effects

26. Methods for estimating effects of regulation: • Intertemporal • Intermarket • Counterfactual

29. Potential outputs: • Each investigator/RA team is working on a working paper/journal article on their component  5 original papers covering the different aspects/disciplines • At Essex we are also working on a paper on corporate governance regulation and indirect productivity effects

30. Potential outputs: • We are working on a joint project literature review for the initiative of Uwe/Ideas factory • Possibly we will develop one other common working paper, report or edited volume

31. The future • Project still on-going (3 out of 5 RAs still working) • End date: 27 December 2006 • Next few months, as we are finishing the individual components, we will explore how the follow-up project should look like • Content • Structure/process

32. The future • Potential link to new institutions • Allan moves to senior position in two new research centres at LMU • Gerben moves to LSE and will explore links with the Centre for the Assessment of Risk and Regulation (CARR) • Stavroula moves to Royal Holloway

33. Conclusion: • Substantial progress made so far • Project has aimed to maximise the benefits from multidisciplinary background investigators • Several potential original contributions made within and across the constituent disciplines

34. Conclusion: • Positive outlook for the future • Given progress made so far • New institutional dimensions/inputs • Reinforcement link to regulation research elsewhere

35. Performance Measurement, Regulation and UK Productivity A Multidisciplinary Overview of Unintended and Indirect Effects Ideas factory Presentation, 10 July 2006 Gerben Bakker, Stavroula Iliopoulou, Joseph Antony, Vlado Balaz, Anjula Gurtoo, Rosalind Rae, Kim Tan, Kathryn Walsh, and Alan Williams Essex-Leeds-Nottingham-Loughborough-Exeter