Competition, Regulation, and Efficiency in Service Industries
Brookings Papers on Economic Activity Microeconomics
IN THIS PAPER I examine the regulatory and competitive environments in which four service industries operate in Europe and Japan, suggesting how certain types of regulation and the lack of adequate competition reduce productivity. I then present estimates of the relative productivities of these industries compared with the United States and suggest that in practice, the differences in the competitive environments of these countries have led to differences in the productivities of the
... Service sector productivity is important. To some observers the international competitiveness of a country depends solely on the performance of its manufacturing sector. But when the productivity of the United States is compared with that of other countries, the service sector is even more important, because it accounts for a much larger share of output and employment than does manufacturing. Understanding why productivity differences across countries exist in a given industry can reveal policy changes that could enhance economic performance or can strengthen the case for policy changes that have al-This study was supported in part by a grant from the Sloan Foundation to the Brookings Institution. Kacy Collins provided excellent and essential research assistance. The productivity comparisons reported here rely on the study of service sector productivity directed by William Lewis of the McKinsey Global Institute. I have benefited from comments made on earlier versions of this paper at seminars at the University of Maryland, Resources for the Future, and the University of Rochester and by Barry Bosworth, Clifford Winston, and others at Brookings. Tom Jansen of McKinsey shared his own work on service sector restrictions with me and provided many useful sources and comments. 71 72 Brookings Papers: Microeconomics 2, 1993 ready been proposed. For example, economic theory has stressed the social cost of the increased price and reduction in output that result when competition in an industry is inadequate. Based on this theory, economists have long advocated competition and deregulation. But the comparisons reported here indicate that certain types of regulation lead to substantial inefficiencies in production and distortions in the natural evolution of industries. Competition that is restricted or regulated can prevent the most efficient producers from entering an industry or from expanding. It can slow the diffusion of innovations and allow managers to operate with excess labor, even relative to the given technology-it leads to slack in enterprises. The effects of anticompetitive policies may be greater than has been generally realized. To illustrate this observation, I point to a recent study that argued that the potential benefits of deregulating European airlines would be smaller than those achieved in the United States because of the structure of the European industry, which has smaller airlines, fewer passengers, and a different route structure from the U.S. industry.' Although granting some effects from differences in geography, I would argue, based on the comparison of productivity in airlines reported below, that all of these industry characteristics will change, probably drastically, if European airlines are deregulated and that the potential productivity gains will be very large. Another advantage of productivity comparisons is that they can affect the way the degree of competitive intensity in an industry is judged. This is often done by looking at the number of companies in an industry or at the market shares of the largest companies. In some situations, however, such measures can be inadequate. The case studies suggest that regulatory policies that prevent the exit of small companies have been a major obstacle to industry evolution and productivity increase in several countries. In the service industries studied here, there are too many small retailers in several countries, too many small airlines in Europe, and too many small banks in Germany and the United States. Competition may be inadequate in other situations as well. For example, although several companies may compete with each other at home, the industry may not be competititve in international markets if it does not have the most productive technologies. Competitive policies toward service industries should allow or even encourage direct foreign investment.