Market economy, govt regulations

Are market economy and government regulations mutually compatible? Most of the businesses in Pakistan – or for that matter in most other developing countries – are likely to answer this question in the negative. Their reasoning would run like this: in order to bring about an optimal outcome, market forces need to be given a full play.

Government intervention or regulations will increase the cost of doing business and bring inefficiencies to the operation of micro-economy. In case, however, the same businesses were asked whether the government should protect them against foreign competition through, for example, import taxes and subsidies, they would answer the question in the affirmative. Why do businesses by and large resist government intervention in the domestic economy but look to it when they face foreign competition?

The above contradiction in the approach of businesses towards the role of the government is largely due to a widespread misunderstanding of the relationship between a market economy and government regulations. The purpose of regulations is not to give the government control over businesses or slow down their operations but to ensure that resource allocation and outcome through profit-maximising private enterprises is optimal for both the corporate sector and society at large.

Not only that, left completely to itself, the market mechanism will break down in at least nine out of 10 cases because of its inherent contradictions. A market or liberal economy can be, and ought to be, a regulated economy. There’s little need for regulations in a planned economy. That’s the reason the process of privatisation is accompanied by setting up regulatory institutions. The United States, which is one of the most liberal economies in the world, is also a highly regulated economy.

It was the laxity on the part of the Federal Reserves, the US central bank, in oversight of the banking sector that led to the 2008 global financialturned-economic crisis. Regulations are necessary for several reasons, such as (a) checking anti-competitive practices by enterprises; (b) safeguarding consumers against unfair business practices and promoting consumer welfare; (c) reducing negative externalities; and (d) protecting the rights of employees.

Rent-seeking

As opposed to the state-controlled economy, the market economy is supposed to be highly competitive due to a fairly large number of suppliers in an industry. The competition among the suppliers leads to efficiency in production and lower prices for consumers. However, at times the suppliers may collude to fix output, create shortages and jack up prices, thus racking up higher profits at the expense of consumers.

Such rent-seeking behaviour is from time to time witnessed in Pakistan’s sugar industry, where despite sufficient sugarcane production, either cane crushing is delayed or sugar suddenly disappears from the market. The sweetener’s shortage bids up its price, often exorbitantly, leaving buyers high and dry. Once the price has escalated, the sugar shortage suddenly disappears. Cartelisation also tends to make the firms less efficient, because the competition-induced incentive to cut costs is removed.

That’s one reason the price of Pakistani sugar is much higher than the commodity’s international price, making it difficult for the local suppliers to compete in foreign markets. Hefty subsidies are needed to enable Pakistan to export its surplus sugar. The antidote to such anticompetitive behaviour is regulations, which promote competition – the Competition Act 2010 – and an independent institution to effectively enforce them – the Competition Commission of Pakistan (CCP).

The efficacy of the CCP in curbing anti-competitive behaviour is open to debate but it’s indisputable that government intervention is essential for safeguarding not only consumers but smaller businesses as well from the predatory practices of big enterprises.

Deceptive marketing

Consumers need to be saved from deceptive marketing practices as well. Such practices pertain to giving false, misleading or incomplete information to the consumers with regard to any matter, which bears upon their purchase decisions. These include product quality, ingredients, uses, performance, origin, warranty, price and qualifications (in case of service providers, such as doctors).

For instance, the consumers may be kept in the dark until the transaction is over whether the price of a service includes taxes or whether a product, such as cosmetics or drugs, can have unintended injurious effects. In Pakistan, the two major laws prohibiting deceptive marketing are the Competition Act 2010 and the provincial Consumer Protection Acts.

Deceptive marketing is not only harmful to the consumers, it’s also detrimental to the national image and the company’s growth prospects. For example, the companies which provide substandard products in the domestic market and get away with it will often fail to get a foothold in foreign markets, where product standards are stringently enforced.

Because of unscrupulous behaviour of a few firms, a country may come to be known internationally as a producer of low quality or substandard products and may lose potential markets for its products. While calculating the cost of producing or supplying a product, businesses take into account only the cost that they have to bear.

However, the process of production may also create costs for third parties. Such costs are called negative externalities. Classic examples are air pollution, disposal of industrial waste in rivers and lakes, and over-exploitation or wastage of natural resources, such as water. Negative externalities often result in production levels which are higher than socially desirable. Appropriate government intervention such as fines or legal action against polluters and progressive water pricing is needed to curb negative externalities.

Protecting workers

Finally, it’s important to protect not only consumers and third parties against unfair business practices but the workers as well. Such intervention may take the form of stipulating minimum wages, maximum working hours, job security, social security, decent working conditions and compulsory worker training. In the short run, such stipulations would add to the overhead costs but in the long run they will make for a more productive labour force and contribute to making an enterprise competitive.

Regulations have their downside as well. If regulations are too many or too stringent, they will stifle economic activity, will be difficult to enforce and may create rents for the officials responsible for enforcing them. A regulation should pass two essential tests: one, regulations shouldn’t be framed for giving the government power over businesses but to achieve a definite policy objective. They shouldn’t unnecessarily burden businesses.

There shouldn’t be two laws if one law can serve the purpose. Two, regulations should be framed realistically, otherwise businesses either wouldn’t be able to show compliance or would find a way of contravening them. For example, minimum wages should be set as per the state of the economy, otherwise businesses will either downsize their workforce or make workers agree to work on less than the minimum prescribed wage.

THE WRITER IS AN ISLAMABAD-BASED COLUMNIST