Franchise Bidding for Natural Monopoly: Concluding Remarks

Whatever their origins, the cost of good intentions needs to be evaluated. The comparative institutional approach to the study of economic organization is precisely designed to do that.

This chapter examines the efficacy of franchise bidding schemes as an alternative to regulation in the provision of public utility services in circumstances where there are nontrivial economies associated with monopoly supply. Granting that regulation is highly imperfect, assessed in terms of an abstract ideal, what are the conditions under which franchise bidding is a vastly superior solution to the supply of “traditional” public utility services?

Surely no one would dispute that the “correct way to view the problem is one of selecting the best type of contract” (Demsetz, 1968, p. 68). But one also needs to be instructed on how to proceed. Although it may be possible to disallow some contracting modes on static allocative efficiency grounds,23 the more interesting cases involve an examination of the efficiency properties of alternative contracts executed under conditions of uncertainty. Contrary to normal practice, attention to transactional detail is needed if the real issues are to be exposed. Additionally, a check on the operational properties of abstract contracting modes is usefully made by examining one or more actual cases in which different modes are being employed.

Microanalytic assessments of the abstract contracting attributes of franchise bidding yield a mixed verdict. Where significant investments in durable specific assets are required and contracts are subject to technological and market uncertainties, franchise bidding in practice requires the progressive elaboration of an administration apparatus that differs mainly in name rather than in kind from that which is associated with the regulation that it is intended to supplant. It is elementary that a change in name lacks comparative institutional significance.

This is not, however, to suggest that franchise bidding for goods or services supplied under decreasing cost conditions is never feasible or to imply that extant regulation or public ownership can never be supplanted by franchise bidding with net gains. Considering the ease with which physical assets can be redeployed, trucking deregulation would appear to have merit. Franchise bidding might also be warranted for local service airlines and, possibly, postal delivery. The winning bidder for each can be displaced without posing serious asset valuation problems, since the base plant (terminals, post offices, warehouses, and so on) can be owned by the government, and other assets (planes, trucks, and the like) will have an active secondhand market. It is not, therefore, that franchise bidding is totally lacking in merit, but that those who have favored it have been insufficiently discriminating in their endorsement of it.26

Applications of the general approach that have since been made include Paul Joskow and Richard Schmalensee’s recent assessment of deregulation proposals for electric power generation (1983). Claims that such deregulation can be effectuated with ease are submitted to careful comparative institutional scrutiny. Characterized as much of the industry is by durable, transaction-specific assets, Joskow and Schmalensee conclude that unassisted franchise bidding is not a viable organizational alternative. Forcing deregulation scenarios through the screen of inicroanalytic analysis is the device by which analytical leverage is purchased. The same strategy is available more gener-ally.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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