A Critique on Raul Fabella’s Government Intervention in the Market: Weak State Perspectives on Regulation and Competition Policy

By Virgil B. Vallecera

I. Introduction

Raul Fabella begins with the classical state and market boundary problem. The adoption of comparative competence is the general philosophy that defines the natural economic boundary between the state and market. Wherever the market has superior competence, the state must retreat in favor of the market (Fabella), or the other way around. However, the boundary is most of the times blurred, comes the tendencies of the market to perform state-owned functions while the state encompasses non-controlled state equity ownerships—and this where regulation comes in in the expense of the firm to make it work better. In the Philippines, economic regulation takes the form of sectoral agencies or boards.

This seeming confabulation of goals among many regulatory agencies may be alternatively be interpreted as a manifestation of the perceived pressure upon developing states to become developmental (Fabella). However, too much dose of regulation, which can take the form of competition policy, may also lead to the halt of developmental or the pursuit of economic capacity building. And the conflict intensifies with the confrontation of the confabulation of goals and regulatory capture, on one end, and the developmental pursuit for economic capacity building, on the other. “Best practice” advocates come in to strike a balance, however, these advocates should also look into the compatibility of the best practice to the level of development of the state.

With multiple regulatory bodies in the Philippine setting, there exists the non-existence of a single entity that tries to prevent or reduce the abuse of market power—a welcome factor for the state to use government threats of takeover at the boardroom.

The absence of a competition watchdog manifests, not government failures, but a developmental state imperative. The liberalization of trade or deregulation serves as a deterrent to abuse of market power of incumbents.

Then, “How should the microeconomy of a developing country be managed to maximize public welfare both of the present and of the future generation?” Notably, the first likely answer came from an unlikely proponent—the apostle of “ruthlessness”, Nicollo Machiavelli. His advice was simple and liberal--“enable the market” by showing merit and honoring those who excel in every art.

Secondly, the success or failure of microeconomic management is best gauged by rapid economic performance and poverty reduction (Fabella) in an economic environment that harnesses latent forces of the market nurtured by good regulatory quality.

II. Contents

The LDC Milieu

The absence of effective third party enforcement engenders firms that have successfully vertically integrated into second party enforcement and political leverage. This in turn, engenders size (for scale and scope economies) and the political connection to parry tendencies towards expropriation by co-opting, preempting, or even capturing the political power. These firms are generally superior to the state in terms of organization, information, and the capacity to perceive and exploit opportunities (Fabella).

The Philippines, like its “big brother” USA, must learn jujitsu by creatively exploiting the potential in its taipans rather than frustrate them. Under favorable incentive structure, taipans can improve collective action capacity. The country should “channel” their energies in a market-enabling regulatory environment geared towards economic capacity building.

Why Regulate the Market

The state regulation of the market has two competing views, namely, laissez faire and market failure.

Laissez faire (“letting be”) best advances that a government governs best that governs least (Nozick and Hayek). In normative libertarian views, the state’s goal is to maximize individual liberty since the market is best left to its own because of its better long-run prospects. This viewpoint also gives emphasis to government failures or situations where the government interventions lead to worse outcomes because of unintended consequences and ignorance of the social context (Clifford and Wolf).

Market failures are situations where the un-intervened markets generate outcomes that are considered to be inferior, unfair, or disruptive. That’s why, some guidance management or regulation by the state would produce better outcomes.

There are seven types of market failures:

1. Negative Externalities – the tragedy of the commons, where private agents fail to consider the cost to others of their actions

2. Positive Externalities – where private agents don’t account for their private benefit actions

3. Public Goods – where private sector under-provides public goods

4. Increasing Reforms to Scale – where natural monopolies settle on one supplier market power by forging large fixed rates and small marginal costs

5. Information Asymmetry – where useful information is held in private; prices become inefficient as signals of scarcity

6. Coordination Failures and Prisoner’s Dilemma Outcomes – where market player’s own interest overruns social outcomes

7. Poverty and Safety Nets – where efficient market outcomes lead to more poor social norms

However, Fabella strictly contends that poverty and income inequality per se are not market failures.

Market failures are based on the following integrative hypotheses where W* is the superior market outcome; W* social outcome; C (m) state intervention transactions cost; hence, W**-C(m) > W*:

In strong states where W**-C(m)↑ <>; hence, creates state failure.

In weak states where W**-C(m)↓ > W*; hence, crates market failure.

In weak states where no information occurs and that there is not capacity to intervene where W**-[C(m)]X > W*; hence, neither state nor market failure.

Therefore, Fabella corrects himself by saying that market failure exists if and only if there exists an intervention m, which when employed by the relevant state results in W**-C(m)>W*. Relevant state should be the reference point.

Regulatory Environment and Economic Performance

In order for growth to be sustained, enabling the market is needed. In weak states, defensive expenditure will swamp value-adding capital expenditure because property rights are less protected, contracts are less enforced, and input and service cost are less reasonable and predictable.

With established sectoral and macroeconomic cross-country evidences, sustainable growth only occurs in a market-enabling regulatory environment and a good institutional quality. Beneficial impact of improved regulatory environment as public good is unequivocal and is clearly imperative for the government.

Deconstructing ‘Good Regulatory Environment’

A good regulatory environment is where rules are formulated to enable the market rather than to extract rents and side transfers. Hence, it should exhibit essential attributes.

1. Transparency –rule transparency and enforcement transparency are present to leave space for conflicting interpretations, which is a source of frequent differential enforcement and rent extraction

2. Regulatory Independence – regulatory agencies should avoid regulatory and political captures

3. Consistency and Predictability – the respect for contracts must be paramount

4. Accountability - there is a clear line of reportage and accountability to reduce abuse; right of appeals; grievance mitigation; oversight agencies like international appeals panels

5. Credibility – regulators should implement and live by the rules

In sum, Albert Hirschman observes the benefits as when “a country that had the capacity to attain these attributes would not remain backward for long.”

Obstacles and Pathways to Better LDC Regulatory Environment

The status quo will be far removed from the ideal and overturning the status quo in favor of the ideal attributes of a regulatory environment is likely a huge problem. It is best to take note of the embeddedness in the culture, the defensive responses to weak state regulatory uncertainties, and the resource and expertise problems.

The regulatory agency is a creature of a state, patronage largesse, where the appointee acts as a fundraiser for the appointer or guardian of appointer’s interest—a tolerated act by the “dominant set of beliefs” (culture per se). In apparent settings, the regulators are agents of the Chief Regulator or the Executive who is acting as the ultimate principal. Regulators serve in the interest of the Chief. Independence can be easily compromised and accountability abused by authorities.

The state, via the regulatory agency, acts as the industry promotion agency that effectively tolerates regulatory and political captures. This acts as a form of “credible commitment” device by the state in the difficult reassurance game with market players.

The regulator doesn’t have as much information as the regulatee about the cost, effort, and purchases. In order to mitigate this, a high level of expertise in auditing and cost accounting which may be missing in Philippine setting. This information asymmetry is mitigated by a regulatory design.

Competition Policy

Safeguarding competition is a public service; an indirect market regulatory device. Where perfect competition exists, direct regulation is redundant for efficiency. However, competition per se, is imperfect. In weak states, there exists a confrontation between the firm-level market power and the weak-state capacity to redress abuse of market power. Fabella then contends that awareness of best practice, however, serves as a powerful catalyst for change.

The two schools of thought Chicago School Tradition (CST) and Evolutionary-Schumpeterian School (ES) lean towards the limited competition policy stance of “free entry” for players willing to contest the dominant player in terms of technological innovation. This stance is boldly manifested by trade liberalization.

In LDC, the difficulty of attracting capital generates market structure that is imperfectly competitive and calls for a more frequent regulation of conduct rather than classical competition policy. Applying an “efficient competition policy” might be misguided since economic size facilitates access to outside capital.

Given the practical and adoptive application of the schools of thought ES and CST as well as the presence of the influential taipans, competition policy is less compelling for LDCs.

A very effective competition policy includes the freer entry and exit; providing better third party enforcement which enables new entrants without second party capability to join the market. Therefore, enabling the market is to refocus the government on proven competence activities.

III. Conclusions/Comments

The absence of effective third party enforcement engenders firms that have successfully vertically integrated into second party enforcement and political leverage. This in turn, engenders size (for scale and scope economies) and the political connection to parry tendencies towards expropriation by co-opting, preempting, or even capturing the political power. These firms are generally superior to the state in terms of organization, information, and the capacity to perceive and exploit opportunities (Fabella).

Jujitsu or the channeling of market energies is indeed a great deal. Not only will it link two great forces but it will pave an environment that is too good to be true. Enough that may bring about either cataclysmic or catalytic reactions of unimaginable proportions that may bring an LDC 20 years behind.

But in the presence of the buffer globalization, an LDC has indeed sacrificed some of its identity or interest in favor of the firm. In a realist point of view, this only welcomes one unwarranted historical fault: Neoimperialism. A case where LDCs have now become peripheries of core metropolitan countries brought about by making the world flatter without just compensation to individual security and sovereignty.

Did the world learned its lessons during the periods of Great Depression? World oil and food crisis, high inflation rates, increased prices of commodities. Too much “letting be” will lead to a new world decline, which in turn, will lead to the patterns that brings the world back to horrific scenes of World Wars 1 and 2. But this time, much advanced and all-encompassing deadly.

The market is somehow a virtuous feline when in domestic scopes but when it crosses international borders, it’s a vicious giant if unparalleled by an effective regulation and competition policy.