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Volume 5 ã Issue 9 ã March 2012 THE ROLE OF CROWN CORPORATIONS IN THE CANADIAN ECONOMY AN ANALYTICAL FRAMEWORK Edward M. Iacobucci and Michael J. Trebilcock* Faculty of Law, University of Toronto SUMMARY Government interference in markets arouses heated emotions on both sides of the political spectrum. But the fact remains that governments of all stripes routinely play a direct role in the economy. Motivations run the gamut from the economic (correcting perceived market failures) to the ethica
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  www.policyschool.ca Volume 5 ã Issue 9 ã March 2012 THE ROLE OF CROWNCORPORATIONS IN THECANADIAN ECONOMY AN ANALYTICAL FRAMEWORK Edward M. Iacobucci and Michael J. Trebilcock * Faculty of Law, University of Toronto SUMMARY Government interference in markets arouses heated emotions on both sides of the politicalspectrum. But the fact remains that governments of all stripes routinely play a direct role inthe economy. Motivations run the gamut from the economic (correcting perceived marketfailures) to the ethical (addressing social injustice) to the nakedly political (ideology or thestatus quo demands it). This paper offers a highly readable theoretical and practicalframework for understanding federal and provincial governments’ market interventions insectors including power generation, alcohol and mail delivery. Public ownership can advancea range of normative objectives, so the choices, reasons and outcomes for the government,the Canadian economy, Crown corporation employees and the general public can vary aswidely as the enterprises involved. But in asking why and how and assessing ways and means,the authors bring together a substantial body of knowledge and expertise, providing anessential guide to a phenomenon that, like it or not, will remain a major part of Canada’seconomic landscape for a long time to come. * The authors are grateful to Julia Potter for her invaluable research assistance.  1. INTRODUCTION Why and how a government decides to intervene in a market are important questions given theimpact these decisions have on economic efficiency and social welfare. In this paper, we discussthe reasons why a government would intervene, and, if so, why it would choose one instrumentover another. We focus in particular on the role of state-owned enterprises (Crown corporations),though one cannot appreciate the case for such an instrument of state influence withoutconsidering the alternatives.The main objective of this paper is to offer a framework for evaluating the policy advantagesand disadvantages of Crown corporations. Because of the broad sweep of considerations andapproaches that might influence thinking on public ownership, general conclusions aboutwhether public ownership or privatization is appropriate are not available. It will often dependon the normative values that one seeks to promote, and in all cases will depend on the particularcontext. As we discuss, however, political, rather than normative, influences can interfere withthe choice to privatize or nationalize an industry, and a deeper understanding of what normativearguments support or discourage the existence of Crown corporations may be helpful inexposing the weakness of certain politically motivated positions on the question.Section II sets out the major rationales for intervention: for efficiency, ethical, or politicalreasons. Section III addresses the different types of instruments available to a government andthe theoretical benefits and drawbacks of each: tighter control through ownership in its variousforms, or less influence through regulation of the private sector. Section IV focuses on Crowncorporations in Canada and compares governmental ownership with different approaches invarious jurisdictions. Lastly, Section V describes proposals for reform, including discussion of why privatization of Crown corporations is often socially desirable but political considerationsprevent it. II. RATIONALES FOR GOVERNMENT INTERVENTION IN THE ECONOMY A: Efficiency Rationales Efficiency is achieved in markets with perfect competition, no externalities, no public goods,and perfect information. Here, competition among suppliers drives the market price to marginalcost. For such markets, there is no need for government intervention (beyond protectingproperty rights and enforcing contracts). However, as Greenwald and Stiglitz discuss, noexisting market meets all of these criteria perfectly and thus none is perfectly efficient. 1 Perhapsreflecting this reality, government involvement occurs in nearly every industry, but to differentdegrees since markets diverge from ideal conditions in different ways and degrees. Of course,government intervention is itself rarely formulated and implemented perfectly either, implyingthat most policy choices are made in a second-best world. For example, government actors maybe prone to the same kinds of bounded rationality that plague private choices, which mightmake one sceptical about the wisdom of government intervention on paternalism grounds. Butthere are a variety of market failures that government intervention could conceivably, even if  1 Bruce Greenwald & Joseph Stiglitz, “Externalities in Economies with Imperfect Information and Incomplete Markets,”(1986) 101:2 Quarterly Journal of Economics 229. 1  not always in practice, address in socially beneficial ways. Natural monopolies, markets withexternalities, markets for public goods, and markets with imperfect information may all justifygovernment involvement on efficiency grounds. Each of these economic rationales forintervention will be briefly sketched below. 1. NATURAL MONOPOLY A monopoly is characterized by a single enterprise having a sufficient market share to the pointwhere it has the power to reduce output and increase the market price of the good or serviceprovided. Monopolies can arise through mergers and increases in market share, or naturally. Anatural monopoly exists where economies of scale are such that average costs fall with eachadditional unit produced. In such industries, the market will tend to result in a single producersince a larger producer always has a cost advantage over a smaller producer. Examples of suchindustries are electricity transmission and distribution and urban or municipal water supply,which require a large investment in capital equipment to set up methods of delivery toconsumers and it is inefficient for competing firms to make duplicate investments. Naturalmonopolists, operating in a profit-maximizing capacity, will restrict output and raise pricesabove marginal cost. Government therefore may have a role in restricting this sociallyundesirable outcome through regulation or public ownership. 2. EXTERNALITIES Externalities — spillover effects that affect third parties — are frequently relied on to justifygovernment involvement in markets. Externalities are either benefits or costs that are realizedby parties outside a particular exchange. Positive externalities may need to be encouraged bythe government because in a laissez-faire free market they are likely to be under-produced.Self-interested actors are not willing to pay for benefits that others will receive. An example of a positive externality is having children inoculated, protecting both the specific child as well asbroader society against infection. Another important example is intellectual property. Ideaswhich are essential to technological innovation and economic growth are often widelyaccessible. Innovations by one firm can be used by competing firms, and this may reduceincentives for enterprises to spend resources on developing innovations. To preserve theseincentives, the government protects ideas through intellectual property right laws so that theinventor can profit from the idea before it spreads through the economy. On the other hand,negative externalities need to be restricted in a laissez-faire economy. In this case, they areoverproduced because their cost is not fully borne by the person that creates them. A commonexample is air or water pollution.Ronald Coase showed that, where transaction costs do not exist, government involvement isnot required in cases of externalities because bargaining between self-interested actors canresult in an efficient outcome even in the presence of externalities. 2 However, as Coase alsostressed, the conditions under which this theorem holds, especially very low transaction costs,may often not exist. Therefore government intervention is often needed to promote ordiscourage positive and negative externalities by creating schemes for internalization of theexternalities. 2 Ronald Coase, “The Problem of Social Cost,” (1960) 3 The Journal of Law and Economics 1 [ Coase ]. 2  3 3. PUBLIC GOODS A public good is one that is both non-rivalrous and non-excludable; it is a good that may beconsumed simultaneously by people who cannot be excluded from enjoying such consumption.Public goods invite a free rider problem in which individuals will seek to take advantage of thebenefits of having the good without the disadvantage of paying for it. As a result, there will bea tendency for the good to be underprovided. 3 An example is the protection provided by thearmed forces or police or fire services. Such protection cannot be offered only to certainindividuals who have paid for it. Therefore the government has an important role in ensuringthat these essential services are provided. 4. INFORMATION ASYMMETRIES Another cause of market failure is information asymmetries. The government may have a rolein protecting the consumer through the reduction of these information asymmetries. Experiencegoods are those for which the quality cannot be determined until after purchase and use. In thiscase, a buyer has less information than the seller about the quality of the good, which leads todistortions in the market resulting in lower-quality goods being sold and fewer exchangesoverall than if there were perfect information. 4 Akerlof famously used the used automobileindustry to illustrate these distortions. 5 If quality is indistinguishable to the buyer at the time of purchase, then this quality level may be estimated based on the average quality of cars for salein the market. But then sellers of above-average cars are reluctant to sell and may drop out of the market. The result of such information asymmetry is a crowding out of high-quality carsand fewer cars being exchanged.The market may be able to correct market asymmetries to some extent through the spread of reputational information and the development of brand names, chains (such as restaurantchains), and warranties which signal to the consumers a particular quality of good. However,such mechanisms will typically only resolve informational deficiencies imperfectly, and therewill be a tendency for the lemons problem to lead to underprovision of certain goods. Theseinformation problems may invite government intervention. The government can also intervenewith licensing requirements or regulating or imposing warranties and guarantees for goods. 6  Credence goods are similar to experience goods but have qualities that cannot be discernedeven after purchase or use. One example is pharmaceutical products and their safety andeffectiveness. Private entities providing such goods would have an incentive to shirk onquality, as it cannot be detected before and after use. 7  Therefore there may be a role forgovernment intervention to certify products and services and test them for safety andeffectiveness. 3 Michael J Trebilcock & Edward M Iacobucci, “Privatization and Accountability,” (2003) 116:5  Harvard Law Review 1422. 4  Ibid. 5 George Akerlof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” (1970) 84:3 TheQuarterly Journal of Economics 488 [  Akerlof  ]. 6   Ibid. 7  Supra note 3
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