Mirco-Economic Policy Essay, Research Paper

Contemporary Microeconomic Management

Objectives of Government Microeconomic Policy

In this subtopic the rationale for government involvement in setting microeconomic policy is examined. The interaction between microeconomic performance and Australia’s economic performance in global terms is reviewed and the concepts of economic efficiency are revisited.

Since the early 1980’s, Government microeconomic policy has been directed towards establishing an environment or a framework within the economy, which is likely to result in competitive outcomes. Why is competition so desirable? What are the benefits of competition that Governments in recent years have been so intent on delivering? Being competitive means being able to produce goods and services that customers want, at a price and quality at least as good as producers in other countries. By being competitive and improving productivity, (the ability to produce more output with the same or less amounts of input) a country such as Australia can achieve economic growth and improve the living standards of it population.

Economic efficiency is an important concept in assessing the level of competition in the economy. There are three measures of efficiency, productive or technical, allocative and dynamic efficiency. Productive or technical efficiency is the ability of firms to use the minimum inputs to achieve a particular level of output. This obviously requires choosing the appropriate level of technology and machinery, good management practices and work procedures and elimination of wastage. Allocative efficiency is achieved when firms produce the mix of goods or services most desired by consumers. That is resources are allocated to industries and firms in accordance with how much consumers want the output they produce. Firms can achieve allocative efficiency by producing up to the point that price is equal to the cost of producing the last unit of the good. Dynamic efficiency is having organisational structures that can ensure that efficiency is achieved over time. That is technological improvements are adopted, and innovations made that ensure that firms and industries can rapidly adapt to changing market conditions.

To achieve efficiency within a firm or sector, both productive and allocative efficiency must be present. There is no use having resources properly allocated between firms and sectors and then producing the output inefficiently. Neither is it useful to produce goods at least cost and then find that there is no demand for them. Achieving dynamic efficiency may involve some trade off with allocative efficiency.

In the move towards a more efficient and competitive economy Australia has undergone significant structural change. That is the type of goods and services Australia produces now are significantly different from what was produced in the 1950’s and 1960’s. This has also involved a changing pattern of trade. The relative importance of each sector as a proportion of GDP can be found in the ABS catalogue.

The Efficient Operations of Markets

Market Structures

The model of perfect competition has long been used as the benchmark or yardstick by which the efficiency of other market structures has been measured. The stringent assumptions of the model, such as the existence of many small firms producing an identical product and with free entry and exit mean that it is generally not found in reality. Both productive and allocative

efficiency are achieved in this form of market structure as the existence of many competitors ensures that production takes place at least cost and prices are driven down to the level where they equal marginal costs.

Most goods in Australia are produced in markets that are either imperfectly competitive or oligopolistic in structure. Most service industries and the tourism sector are imperfectly competitive with the number of firms meaning that monopoly profits are unlikely in the long run. In contrast to perfect markets, competition takes place in many ways apart from price. Service, quality and consumers perceptions of image are important.

The bulk of manufacturing industries operate in an oligopolistic market structure due to the high barriers of entry often generated by significant economies of scale. Food retailing, car manufacture, newspapers and brewing are industries characterised in Australia by a few large producers. These industries tend to enjoy the existence of monopoly profits as they are protected against entry of competitors. Non-price competition, such as branding is important in this type of market structure.

So how can efficiency be achieved when the two dominant market structures in Australia do not necessarily deliver these benefits? The theory of contestable markets asserts that the benefits of efficiency can be achieved even if the number of firms in the industry is small. A perfectly contestable market is one which allows easy entry and exit of potential competitors without loss of any of the investment needed to enter the market. This implies that there are no sunken costs in the industry. Assets must be easily transferred to other uses, or there must be an active secondhand market. Existing firms, aware of the threat of entry from other firms, will set prices so that no monopoly profits are earned. In addition they will produce goods in an efficient way otherwise they are exposed to attack from new entrants producing at lower cost. Therefore if a market is contestable, then efficient outcomes can be achieved, as firms behave in a manner which deters entry of new firms.

Market Failure

There are instances where markets fail to deliver efficient outcomes or fail to provide the good at all. In these cases governments intervene in markets. There are two cases of market failure you need to be aware of, natural monopoly and public goods. Natural monopoly arises where it is more efficient to have only one provider of a good or service. This happens when there are very high fixed costs and very low marginal costs associated with production. An example of this is electricity transmission, where it would be an inefficient use of resources to have more than one provider. Traditionally, governments have responded to this problem by owning and operating the facility. However, more recently governments have moved towards separating the day to day operations of the asset from the ownership function. Regulators set the operational guidelines for the efficient running of a natural monopoly. The major issue facing regulators is what price to charge for access to the facility or service. There are several pricing options including marginal cost pricing and average cost pricing.

The other type of market failure is the provision of public goods. Public goods are characterised by two features, nonexcludability and nonrivalous consumption. That is, it is impossible to exclude anybody from benefits of consuming the good or service and two or more people can consume at the same time without impacting on the other persons consumption. Free to air television is an example. Once people have a television set (receptor) there is no way that they can be excluded from viewing. In addition, there is no limit to the number of people that can watch (or consume) a particular program at any one time. Other examples of pure public goods are national defence, justice and policing. Private firms would be unwilling to provide these types of goods because it is impossible to exclude non-payers and so consumers are able to “free ride” (consume without paying). In response, governments tend to provide the goods on behalf of society. In the case of free to air television, private operators can make profits through advertising sales and so the government’s role is one of licensing and regulation of operators.

Microeconomic Policies

In 1995 the Council of Australian Governments agree to implement the competition policy reform package, which extended the Trade Practices Act to cover previously exempt areas of the economy. These were State Government business enterprises such as electricity and water providers, statutory marketing arrangements as found in many agricultural markets and unincorporated enterprises. The package also sets out a process for the review and reform of regulations and other interventions that impede competition in the economy.

New institutional arrangements were formed to advance the competition reforms. The main regulatory body monitoring competitiveness in the economy is the Australian Competition and Consumer Commission (ACCC) chaired by Professor Allan Fels. The ACCC is the competition watchdog, monitoring and investigating firms and industries to minimise anti-competitive behaviour. The Commission was formed from the merger of the Trade Practices Commission and the Prices Surveillance Authority.

Competition policy extends and builds on the microeconomic reform process begun in the 1980’s. These policies involved reforming government owned enterprises, reducing protection in manufacturing industries, restructuring the taxation system, reforming labour markets, and improving education and training.

Infrastructure

Government business enterprises (GBE’s) such as electricity supply, water supply, postal services and gas supply, are an important part of the Australian economy. These industries have been characterised by inefficient production due to inflated costs resulting in higher prices to consumers. The lack of competitive pressures (typically these industries are monopolies) and absence of any clear profit motive lead to “gold plating” of inputs where costs were not minimised. In addition, many of the GBE’s have a mixture of objectives, some of which are socially orientated (known as community service obligations). For example the maintenance of loss, making rail services to country towns, is a social objective not a profit maximisation objective and it may lead to higher costs for all consumers.

Two major approaches taken to provide an incentive structure to improve the technical efficiency of GBE’s is privatisation and corporatisation. Privatisiation involves the sale of publicly owned assets to the private sector. In the past five years, there has been a spate of privatisations at both the Commonwealth and State level. Some examples of this are the sale of the Commonwealth Bank, Qantas/Australian Airlines, one third of Telstra, and several electricity generators in Victoria and GIO in New South Wales. The case for privatisation rests on the belief that the lack of a clear profit motive causes inefficiency in public enterprises.

If ownership is transferred to the private sector then the profit objective will be pursued with resultant efficiency gains. However, in general, these entities face little competition when privatised or hold considerable market power due to their size. In these situations governments have appointed a regulator to oversee market operations and pricing.

Corporatisation involves the setting of clear objectives for the enterprise, performance related pay for managers and the monitoring of the enterprises financial and productive performance. This involves separating the day to day running of the entity from the ownership function. This separation minimises government interference in operational issues and forces governments to explicitly fund community service obligations out of State and Commonwealth budgets.

Trade and Industry

Until the late 1980’s Australian manufacturing industries were highly protected. These industries were cushioned from competition with other countries via high tariff barriers and subsidies on inputs. As a result, productivity in these industries was very low, design innovation was stifled and product quality inferior compared to other countries. Manufacturing industries are an important focus for microeconomic policies because they are either potential exports or import substitutes. Since the mid 1980’s Australia has had a persistent and growing deficit on the current account. One solution to this problem is to improve the balance of trade, that is, increase exports and decrease imports. To encourage an increase in exports from manufacturing industries, domestic industries need to increase productivity and competitiveness.

In response to this, in 1988, the then government announced reduction in the tariff for most manufacturing industries and a timetable for the phasing down of tariffs to an estimated effective rate of protection of 5 per cent by 2000. By and large these tariff reductions have been implemented. However, in 1997, the government froze tariffs in the most heavily protected industries, passenger motor vehicles and clothing, textiles and footwear. This slowdown in reform was justified by the government (and industry) as being necessary to contain the adjustment costs experienced by these industries.

In addition to the removal of tariff barriers to trade, governments have attempted to improve productivity in the sector by encouraging research and development. This has been achieved through providing taxation credits to companies that undertake research and development expenditure.

Government policies to increase productivity in the manufacturing sector have incorporated removing subsidies and tariffs and encouraging investment in research and development. However, the pace of microeconomic reform in other sectors of the economy has a major impact on productivity improvements in manufacturing industries. This is due to the fact that many other sectors provide inputs to manufacturing industries. In order for manufacturing industries to achieve productivity improvements, reforms have to occur in other sectors.

Labour Markets

Labour is a major input into all sectors of the economy. In order for productivity improvements to be realised across all sectors, reform of labour market policies has been necessary. This process has been slow and at times confrontational. Unions used to negotiate awards on behalf of their members. These awards outlined conditions, duties and associated rates of pay. Enterprise bargaining is the process whereby employers negotiate these issues directly with their employees. The benefits are a more flexible labour force that is tailored to the needs of the business and of the workers within those businesses.

In addition, governments have focussed attention on the skills needs of the Australian workforce. In order to meet the needs of industry, on-the-job and more formal education and training programs have been encouraged.