Difficulties of Deregulation When Wage Costs are the Major Cost

Abstract

Most regulated industries undergoing deregulation are capital intensive. In the existing cost-of-service regulatory framework, the primary concern is that guaranteed a competitive return on capital, the regulated firm has insufficient incentive to be cost efficient. In deregulating firms in such industries the return on capital is permitted to vary directly with the firm’s performance. Firms that restrain costs and increase revenue can earn higher profits, while those that fail to do so see profits fall below levels assured under the prior regulatory regime. The assumptions in deregulating such industries are that the affected firm can control the bulk of its costs, can make decisions with little remaining governmental oversight, and can use high-powered performance pay incentive systems to encourage profit maximization. In addition, it is assumed that regulatory barriers will eventually disappear, allowing for open markets and free competition.

The authors appreciate helpful comments from Don Develin, Andy German, John Leeth, Maura Robinson, and Ed Ward, and computational assistance from Timothy Gill.