Why Financial Deregulation?

Over the past six years, financial markets in Australia have been deregulated almost completely. This article attempts to explain why Australia's financial markets have been deregulated and why financial deregulation has occurred so quickly. It suggests the answers lie in changed perceptions of the usefulness of regulation as a means to specific ends. Exogenous developments in the financial environment altered the impact of regulations on financial institutions. The result was a weakening in the competitive position of regulated financial institutions relative to unregulated financial institutions and direct financiers. This led simultaneously to a reduction in the ability of the monetary authorities to control the growth of total financing and a growing perception amongst regulated institutions that the costs of regulated status outweighed the benefits. The rapid demise of the regulations can be traced to the joint realisation by the monetary authorities and the regulated institutions that the regulations no longer served their respective ends. This conjunction of 'public interest' and 'private interest' in financial deregulation can in turn be traced to the unique ability of financial markets to generate close substitutes for existing financial products at low cost.     

Neither market nor hierarchy—coordination costs in the allocation of track capacity in the Swedish railway network

Transaction costs have been an issue since the advent of the deregulation of the European railway markets in the 1990s. Transaction cost economics received renewed attention in research on the deregulated railway markets in the EU after the publications of two influential reports in the early 2010s. In this article, we develop a model that enables classification and measurement of transaction costs and other coordination costs in deregulated markets. This model is then used to analyze the costs of path allocation in the Swedish railway sector and to compare the results with findings in previous research. We also discuss the economic rationale of the distribution of coordination costs among the involved parties. Our key empirical findings are that the total coordination costs in the Swedish market-mimicking path allocation process are as low as or lower than the most cost-efficient market coordination processes studied in railway markets, and that the state administrations take on nearly all the coordination costs in order to minimize the effects of opportunism, rent-seeking and information impactedness. Another finding is that the size of the coordination costs found by different studies seems to be dependent on whether a bottom-up or a top-down approach is used.     

Cost Savings and Productivity in the Railroad Industry

Railroad deregulation has had tremendous effects on the level of costs and productivity gains. I use an unbalanced panel of railroads from 1978 through 1989 to estimate a translog cost function. I find that initially cost savings from partial deregulation were modest. However, by 1989, I find that cost savings were tremendous, with costs being up to 40 percent lower than they would have been under regulation. I also find that while initial effects of deregulation on productivity gains were large, these effects have fallen through time, and currently are comparable to pre-deregulation levels.     

Deregulation,news releases,and price discovery

We hypothesize that the firm’s regulatory environment influences the sensitivity of its equity value to information. Using intraday stock price data of utilities operating in differing regulatory environments we test for systematic differences between the responsiveness of stock prices of utility firms operating in deregulated and regulated environments to a common information set. Our findings reveal sharp differences in responses, with those of utilities operating in deregulated environments the strongest, and the responses of utilities in highly regulated environments the weakest. While the evidence supports our hypothesis, in a broader sense, the evidence suggests that deregulation aids in the process of price discovery. We also find evidence that suggests that deregulation, per se, does not lead to higher stock price volatility.      

Stranded Costs,Takings, and the Law and Economics of Implicit Contracts

Economic Analysis can help resolve the stranded cost controversy that has arisen in debates over electricity market deregulation. "Stranded costs" are costs electric utilities will not recover as power markets move from protected monopolies to an open, competitive environment. We describe the stranded cost problem, its magnitude and the prominent arguments for and against recovery. An economic analysis of implicit contracts can clarify whether there should be a legal duty to compensate utility shareholders for unrecovered costs. However, efficient approaches to electricity deregulation should rely on more than analysis of contracts. The politics of deregulation, as reflected in optimal compensation for regulatory "takings" of property, also affects the desirability of stranded cost recovery.     

Regulatory tune-ups

Regulators cannot continuously and perfectly monitor firms. The alternative considered here supposes the regulator sets prices at discrete, unforeseen, times. I show that when marginal cost follows a stochastic diffusion process, but the regulator only irregularly adjusts the regulated price, the optimal price may be less than or greater than the expected level of marginal costs. The regulated price should be higher the steeper the demand curve, the lower the discount rate, and the greater the variance of costs. The social benefit of changing the price following a change in marginal cost is usually greater if at the time price was set marginal cost was low.     

Housing Interest Rate Deregulation and the Campbell Report*

It is argued that deregulation of housing interest rates would, under plausible assumptions, substantially increase the cost of housing finance in Australia, contrary to the impression created by the Final Report of the Australian Financial System Inquiry (the Campbell Report). Characteristics of the market for owner-occupier housing finance, on both the demand and supply sides, suggest that the deregulated market rate will be approximately equal to the uncontrolled rate under regulation. The weighted average interest rate for owner-occupier housing finance at December 1981 is more than three percentage points below the uncontrolled rate. The authors conclude that while this result does not of itself constitute an argument against deregulation, it does imply that deregulation would have a substantial distributional impact .     

Cross-subsidization and cost misallocation by regulated monopolists

While cross-subsidization is understood theoretically as involving the sustainability of a cost allocation scheme, it is invoked in regulatory policy contexts, such as the divestiture of AT&T, where costs of serving unregulated markets may be borne by ratepayers of regulated monopolies. We analyze two cross-subsidization tactics—cost misallocation and distorted technological choice — under a spectrum of regulatory cost allocation policies. These tactics lead to higher prices in regulated markets and inefficient production in unregulated markets. Welfare effects are discussed; we conclude with observations on strategic behavior and regulatory policy.     

Investment Incentives of a Regulated Dominant Firm

We study the investment incentives of a regulated, incumbent firm in a deregulation process. The regulator cannot commit to a long-term regulatory policy, and investment decisions are taken before optimal regulatory policies are imposed. We characterize the regulated incumbent's incentive to invest when a deregulation process is initiated and an unregulated firm enters the market as a result. The change in the marginal return to investment depends on how the investment changes the firm's virtual cost—the sum of its physical production and information costs. When the marginal return to investment increases due to deregulation, social welfare increases as a result of higher investment and more competition. Otherwise, the change in social welfare depends on the total of the effects in the fall of investment and increased competition. We also present conditions under which deregulation enhances welfare.     

Cost savings and deregulation: an analysis of fuel cost savings in deregulated electricity markets

Unregulated utilities face competitive pressures that lead to cost-minimizing activities, but regulated monopolies in the US electricity generation sector face pressures only from regulators who must balance a desire for lower prices against the need for the utility to generate a sufficient return to encourage investment. This paper analyses the cost-minimizing behaviours of regulated utilities by comparing their average input coal costs with those of deregulated utilities purchasing coal from the same mine during the same month of the same year. Results indicate that coal-fired electric plants operating in deregulated electricity markets negotiate prices that are 6.1 ¢/MMBtu (3.5%) less than their regulated counterparts. In percentage terms, this is a fairly small discount for deregulated plants, but it happens to be on par with the restructuring gains that others have estimated for labour and nonfuel costs.     

SOME PUBLIC POLICY ISSUES RAISED BY THE DEREGULATION OF FINANCIAL INSTITUTIONS

Successful deregulation of financial institutions promotes flexibility and effeciency while avoiding the instabilities and abuses that characterized the financial system prior to the reform legislation of the 1930s. It is essential that deregulation nut undermine the efficacy of deposit insurance. The growth of money market funds has already resulted in a shift from insured to uninsured accounts. With deregulation there will be much larger shifts of funds to uninsured transactios accounts. In a deregulated world, it is essential that insurance be extended to cover transactions accounts, no matter who issues them, The paper also asserts that existing statutes are inadequate to deal with the conflicts of interest and anti-competitive practices that are likely to occur with deregulation. Safeguards should be established before deregulation goes any further. Finally, it is argued that in a deregulated environment, most forms of money will pay interest, and required reserves will disappear. While these developments will not destroy the efficacy of monetary policy, they will affect it. Little work has been done an the issue of monetary policy in a deregulated world. The paper discusses existing studies and suggests some topics for future research.     

LIBERALIZATION WITHOUT DEREGULATION: U.S. TELECOMMUNICATIONS POLICY DURING THE 1980s

During the past 20 years, the U.S. telephone industry has undergone a remarkable evolution from a set of government-enforced monopolies to a much more competitive environment. Long-distance service, private-line service, data communications, and terminal equipment once were available only from the telephone monopolist. Now they are freely available from numerous competitive suppliers due to a series of regulatory and judicial decisions. But despite this veritable explosion in competition, the telephone industry still is regulated at both the federal and state levels. Only the provision of terminal equipment is totally deregulated.
Regulating telephone rates has created a highly inefficient rate structure replete with cross-subsidies. Legislators' and state regulators' reluctance to eliminate these cross-subsidies remains the most important hurdle to transforming the telephone industry to a fully competitive market. Nevertheless, liberalizing entry has generated some economic efficiencies through its effect on productive efficiency and on regulated rates. Productive efficiency gains may have reached $3 billion by 1988, and the welfare gains from the limited rationalization of rates caused by entry are nearly $1 billion per year.
Fully deregulating long-distance and local service requires that regulators abandon their policies of cross-subsidizing rural residences at the expense of businesses and of cross-subsidizing local service at the expense of long-distance service. Movement toward deregulation is progressing at the federal level and in some states, but full deregulation appears unlikely in the foreseeable future.     

Costs under Regulation and Deregulation: The Case of US Passenger Airlines*

Privatization, the removal of regulatory control and similar changes in property rights within firms can be expected to shift cost functions downward and permit increased output, lower final service prices and more efficient resource allocation The US Airline Deregulation Act of 1978 was clearly expected to have these effects. This paper investigates whether the widely anticipated reduction in costs following the Airline Deregulation Act of 1978 actually occurred. We utilize an empirical procedure that explicitly takes the multi-product characteristics into account and identifies the various sources of changes in costs. The change in airline's costs are decomposed into components and separately measured to identify the effects attributable to deregulation A number of other countries are now considering important changes in the public ownership and control of their airline industries and a quantitative assessment of the actual effect of US deregulation on costs may be thought of as providing lower bound estimates of what might be expected in other countries.     

How fast does product market reform pay off? New evidence from non-manufacturing industry deregulation in advanced economies

The paper sheds light on the issue of how fast product market deregulation pays off and whether it entails any transitory costs by using a unique mapping between a new narrative dataset of major reform events and sector-level outcomes for 5 major non-manufacturing industries in 26 advanced economies over the period 1975–2011. Using a local projection method, we find that deregulation pays off only gradually: its positive effect on output becomes statistically significant three to four years after the reform, consistent with the notion that entry takes time due to real frictions. At the same time, there is no evidence of any significant transitory cost. Over the medium term, these product market reforms eventually yield large, highly significant increases in output, concomitant with a relative price decline. The typical major historical reform in advanced economies increased real value added and employment in the deregulated industry by about 10 percent and over 5 percent, respectively, and lowered relative prices by some 8 to 10 percent, after five years.     

Technological progress in particulate removal equipment at U.S. coal burning power plants

Coal-fired power plants contribute significantly to particulate matter emissions, which are regulated in the U.S. with emissions standards set by individual states. The theoretical literature generally, though not always, finds that standards offer inferior incentives to develop and adopt technological innovations, especially in end-of-pipe pollution control. This analysis empirically tests for cost-saving innovations in the operating, capital, and lifetime costs of flue gas particulate collectors. Results suggest that operating costs have fallen over time, capital costs have increased, and that these changes have led to no statistical change in lifetime costs.     

Why shops close again: An evolutionary perspective on the deregulation of shopping hours

This paper introduces a new perspective on the deregulation of shopping hours based on ideas from evolutionary game theory. We study a retail economy where shopping hours have been deregulated recently. It is argued that first, the deregulation leads to a coordination problem between store owners and customers, and second, the ‘solution’ to this problem depends on the specific cost structure of stores and the preferences of customers. In particular, it may happen that, even if extended shopping hours are Pareto efficient, stores and customers do not succeed in coordinating on this equilibrium. The analysis explains the observation in Germany, where shopping hours have been deregulated recently, that store owners tend to go back to the former shopping hours again. Moreover, it emphasizes the important role of advertisement campaigns as a signalling device.     

Deregulation and regional specialization: Evidence from Canadian agriculture

For about 70 years, the Canadian Wheat Board (CWB) was one of the world's largest export “single desk” state traders in agriculture, until it was deregulated in 2012 and stripped of its marketing powers. One of the main crops controlled by the CWB was barley. We estimate the impact of the removal of the CWB's single desk on the spatial pattern of malting barley production in Western Canada. We find that deregulation encouraged growers located closer to malt barley processing plants to increase production relative to growers located further from the plants. This change in cropping patterns after deregulation can be explained by efficiency gains, combined with transportation and handling cost savings.     

Allocation of pollution abatement under learning by doing

This paper examines how learning by doing affects the allocation of pollution abatement between heterogeneous technologies over time. The optimal policy balances current abatement costs against reductions in future costs and infant technologies may be preferred to mature technologies despite greater initial costs. We characterize when a technological winner might emerge and we identify conditions under which optimal abatement is shared across all technologies. Pigouvian taxes can implement the first-best, but may need to be differentiated across technologies. When technical change is induced, an important role of environmental policies is to put abatement on the right technological trajectories.     

Regulating Prices to Equal Forward-Looking Costs: Cost-Based Prices or Price-Based Costs?

This article defines "forward-looking cost," identifies conditions under which forward-looking costs can be calculated, and explains the relationship among forward-looking costs, depreciation and utilization. It derives a framework to account for the risk of asset death, changes in the cost of new capital, demand growth and uncertainty, and competition risk. The potential for competition, asset life uncertainty, and the installation of excess capacity in anticipation of demand growth raise forward-looking cost. The potential for technological change that enhances the future value of an asset lowers forward-looking cost.     

The Value Relevance of Earnings and Nonearnings Information in Regulated and Deregulated Markets: The Case of the Airline Industry

This paper examines the valuation effects of earnings and two nonearnings-based measurements (book values and operating cash flow) on security prices of airline companies under two different market structures: regulated and deregulated. The literature lacks empirical evidence in examining the relative importance of earnings and nonearnings accounting-based measurements in regulated and deregulated markets, especially in the airlines industry. We compare coefficient estimates of regressing stock prices on earnings, book value, and cash flow from operations of airline companies during regulated and deregulated times. A control sample of manufacturing companies is also used for supporting inferences from the airline sample’s findings. In a typical regulated market, using cost recovery plus an adequate rate of return on assets, security prices are highly aligned with nonearnings measurements such as the book value. In the airline industry, regulation took the form of guaranteed routes and subsidies to service rural areas, giving rise to a differential effect of both earnings and nonearnings measurements. Under deregulation, airline firms operate in highly competitive markets with large airline firms enjoying the benefits of economy of scale and service diversification. Thus, the asset capitalization (book value), cash flow, and operational efficiencies (earnings) would be major indicators in the market assessment of the firm’s future profitability and security price. This paper finds that nonearnings measures have higher explanatory power of security prices in regulated times for the airline firms. In deregulated times, although earnings have a stronger relationship with prices, nonearnings measures continued to influence stock price levels, reflecting airline specific economics.