Difficulties of Regulation 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 within 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; for those that do not do so, 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.

For the United States Postal Service a number of these assumptions do not hold. The Postal Service is labor rather than capital intensive, important postal costs are not directly controlled by the firm, the USPS will remain government-owned, at least in the short term, and barriers to competitive markets will be lowered but not eliminated. Consequently, deregulating the Postal Service using the private sector, price-cap model poses risks that are both unique and considerable. At the same time, regulatory reform in postal markets has some significant advantages over prior experiences in other industries. Most importantly, skepticism about the ability of deregulation to improve competitiveness and market efficiency has proved incorrect. Although far from flawless, deregulation has been, on balance, successful in airlines, trucking, natural gas, and telecommunications. We also have learned that reform legislation need not be technically perfect to achieve positive results. The key is for regulators to begin the process of opening markets to competition and allow market forces to drive the adjustment process. Finally, as discussed elsewhere in this volume, postal deregulation in other countries has achieved positive results. In this paper, we primarily deal with two deviations from the traditional deregulatory model: the Postal Service is labor- rather than capital-intensive and the Postal Service does not directly control important elements in its cost structure.

Working Paper Series