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Service Oligopolies and Economy-Wide Performance in Taiwan: a CGE Analysis

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Service Oligopolies and Economy-Wide Performance in Taiwan: a CGE Analysis Service Oligopolies and Economy-wide Performance in Taiwan: A CGE Analysis Ping-Kun Hsu∗ School of Economics College of Business and Economics The Australian National University Tel: + 61-2-61251178 Fax: + 61-2-61255124 Email: [email protected] ∗The author would like to thank Professor Rod Tyers for the overall supervision and Iain Bain for his helpful modelling programming assistance. Comments and suggestions from 2008 Ph D Conference in Economics and Business are gratefully acknowledged. All errors and omissions in this paper are solely that of the author. Abstract This paper mainly examines the economy-wide implications for the regulation and privatization of service sectors, taking explicit account of imperfect competition. A computable general equilibrium model of the Taiwanese economy is constructed that represents monopoly and oligopoly behaviors and the regulatory environments facing major firms. Simulations on the potential implications of oligopoly behavior and price-cap regulations are conducted to examine the implications of oligopoly rent for real wage rates, output and the extent of sectoral interactions. While simulations on the economic reforms in the tradable sectors are conducted to identify whether the gains from the trade liberalizations in the tradable sectors can be increased or decreased by the presence of the price-cap regulations in the profitable privatized services industries. Hypothetical cartelization is shown, not surprisingly, to cause a substantial reduction in real GDP and in real wage rates. The potential implications of oligopoly behavior are first examined by estimating the economic costs of the hypothetical full exploitation of oligopoly power. Relative to a 2001 benchmark, the potential gains are then assessed from tighter price-cap regulations. By contrast, price-cap regulations lower prices, expanding demand and benefiting the unregulated sectors via the lower cost of regulated intermediate inputs. Lower home costs also cause the real exchange rate to depreciate. This then fosters expanded exports which further bolsters demand for home goods. The results show that collective oligopoly behavior is not linear in proportional changes, suggesting the merit of economy-wide analysis. Finally, trade liberalizations do not always reduce the mark-ups of the services industries, resulting in the pro-competitive effects whether the economy is initially subject to the price-cap regulations or not. Key Words: Regulation, Oligopoly, Services, Price Cap, Cartelization, Privatization, CGE, Taiwan JEL Codes: C68, D43, D58, L13, L43, L51, L80 i 1. Introduction Taiwan became a member of the World Trade Organization on 1 January, 2002. Since then, it has continually pursued trade liberalizations and structural reforms, especially in the services sector where shares in GDP and employment have risen and labor productivity is substantially higher than in the rest of the economy. Taiwan’s services sector as a whole commands most of the economy, approximately 73% of GDP and 58% of employment, and its real growth rate calculated at 2001 prices reached 2% in 2008 compared with the whole economy’s rate of 3.2%.1 Services sector continues to expand rapidly and ten state-owned enterprises (SOEs) are scheduled to be privatized and deregulated in the years to come. These include SOEs from the electricity, petroleum, transport, finance, other services and manufacturing sectors. By the end of 2007, the share of SOEs in GDP was 3.14% and the share of the sectors from which SOEs came accounted for 10.3% of the GDP. 2 The non- government part of the services sector in Taiwan tends to be oligopolistic and is routinely subject to regulation. Analysis of regulatory reform in other countries shows significant implications for the economy as a whole, including effects on capital and labor market, and other unregulated sectors through the cost of services supplied as intermediate inputs. To examine this in the case of Taiwan requires a model that incorporates clearly the monopolistic and oligopolistic behavior which would be exhibited by service firms unfettered by regulation. Such a model will be helpful to explain the implications of privatization and regulatory reforms for major important variables like the level of output, investment, employment, wage rates and overall economic growth. Given the fact that changes in regulatory policies have significant implications for all the regulated sectors and that those sectors are now large contributors to the economy as a whole, there is a need for an economy-wide analysis of regulatory reform which explicitly represents monopoly and oligopoly behavior. 1 These numbers only cover the first three quarters of 2008. 2 By the end of 2004, the share of SOEs in GDP was 4.7% or NT$482.6 billion (6.4% at the end of 2001); employees in SOEs accounted for about 1.7% of all employees in Chinese Taipei in 2004. In 2004, SOEs generated 8.4% of imports and 1.7% of exports (7.4% of imports and 1.1% of exports in 2002). 2 In recent decades, studies of regulatory policies have tended to focus on the partial equilibrium analysis of individual industries. When such policies span half the economy, however, partial equilibrium analysis is incomplete due to its discounting of economy-wide effects. This paper examines the economy-wide implications of privatization and regulatory regimes over imperfectly competitive services for the level of output, investment, employment, wage rates and overall economic growth. A mathematical model of the Taiwanese economy representing monopoly and oligopoly behaviors and the regulatory environments facing major firms is constructed. In addition, a broader database is created to support the model covering Taiwan’s whole economy. All firms are oligopolistic, interacting through prices. Simulations on sectoral interactions with oligopoly and tighter price cap regulation in the short run are conducted in order to examine the implications of oligopoly rent for real wage rates, output and the extent of sectoral interactions. On the other hand, simulations on the economic reforms in the tradable sectors are conducted to identify whether the gains from the trade liberalizations in the tradable sectors can be increased or decreased by the presence of the price-cap regulations in the profitable privatized services industries. As parts of its commitments to economic liberalization and internationalization, Taiwan started to privatize state-owned enterprises by amending relevant laws and regulations in the early 1990’s.3 To date, 34 formerly SOEs (about 70% of SOEs planned to be privatized) have been privatized, 17 are closed, and three state-owned banks have been turned into three financial holding corporations. Two SOEs are decided not to be privatized at this stage. Ten remaining SOEs are scheduled to be privatized in the future except the Taiwan Water Corporation. Price regulations are imposed in some industries, like petroleum and energy, electricity, water and telecommunications. These markets are either monopolies or oligopolies. The government regulates these industries to stabilize the current prices. For example, the government reviews oil and gas prices charged by a major state- owned supplier every Friday, thereby influencing the market price. The price of 3 The privatization of government-owned enterprises will be executed by way of sales of shares, sales of assets through bidding, formation of a private-owned enterprise by joint venture with private individuals by way of contribution in kind, merger of companies with the surviving enterprise being a private-owned enterprise, and capital increase by cash. 3 electricity is regulated fully based on the weekly recommendations by the oil and power consulting commission under the Bureau of Energy. Regarding the telecommunication sector, services provided by type I enterprises (facilities-based operators) are subject to price cap regulation by National Communications Commission (NCC) and tariff determined by type II enterprises (non- facilities-based operators) must be notified to NCC. The remainder of this paper is organized as follows. In section 2, we present an oligopoly model of the Taiwanese economy, including model structure, closures, database and calibration. Section 3 analyzes the potential implications of oligopoly behavior. This is followed by the short-run effects of price cap regulation in section 4 and the economic reforms in the tradable sectors in section 5. Finally, section 6 summarizes the results and concludes. 2. An Oligopoly Model of the Taiwanese Economy The analytical framework stems from a prototype model originally constructed to analyze the pro-competitiveness effects of trade liberalization in manufacturing by 4 Tyers (2004, 2005). It was subsequently applied to the Australian economy by Tyers and Rees (2008). The version applied to regulatory policy has a number of adaptations. These adaptations are behavioral equations to examine the effects of regulatory policy, including Ramsey price-cap, and a government sector that spends in line with tax revenue collected from both direct and indirect taxes.5 In addition, for this particular study, a new database is constructed that emphasises Taiwan’s service industries. Finally, following Tyers and Rees (2008), for stability in the tradable goods sectors a restructuring of the model’s treatment on foreign goods is required. In this model, foreign goods are assumed to be homogeneous in each sector but differentiated from corresponding generic home
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