Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Tuesday, January 25, 2005

Privatizing a Gubmnt Monopoly

For several years, the Province of Ontario has been making noises about privatizing its monopoly over the retail sales of liquor and wine [The Liquor Control Board of Ontario (LCBO)]. The LCBO is a monopoly that returns profits to the province of nearly $1billion per year. How much do you think the province could receive if it were to sell off the LCBO monopoly to a private investor?

As all good economists would say, "That all depends."

If the gubmnt sells the right to continue to extract monopoly rents (and impose higher transportation costs on consumers by having too few outlets), then it will receive only the net present value of the expected future profits of the purchasing firm. Consumers will not be any better off, and given that a monopoly purchaser would probably face more risk and a higher cost of capital than the province, there is a very good chance that the monopoly is worth more to the provincial gubmnt than it would be to anyone else.

This is the nub of the argument made in a series of television ads over the past several years from the employees of the LCBO. But it misses the point. If the gubmnt isn't going to get rid of the monopoly, there probably isn't much point in privatizing the LCBO!

The main goal of privatization should be to increase overall welfare [however that is determined is always a puzzle]. But if the goal is to make people better off in general, there is a tonne of compelling theory and evidence that competitive markets work best. And so if the gubmnt of Ontario decides to privatize the LCBO, it should also guarantee free entry into liquor and wine retailing. Of course, no private entrepreneur would pay much for the existing monopoly if they knew there would be free entry into the market, a point made really well by Terence Corcoran
[National Post; Date: Jan 22, 2005; Section: FP Comment; Page: 49, pd. subscription required] in his piece "LCBO Not Fit for Sale" [Thanks to Jack for the reference]:
Replacements for the LCBO’s stranded assets would be productive,
profitable and efficient operations run by supermarkets and specialist retailers — all of which would be much better for the Ontario economy than the dead-weight drain of the LCBO.
There are two issues here. First, even if pricing isn't deregulated, consumers will be made better off if they can shop more conveniently for wine and liquor, say in corner variety stores, grocery stores, or Wal-Mart. Second, consumers will be made even better off if various retail outlets compete on the basis of price, too.

The point is, it should not be about who gets the right to extract monopoly rents from consumers. It should be about increasing consumer surplus and reducing the costs of providing the services to consumers.

There is only one reason the LCBO employees spent so much money on their ads: they are getting a healthy chunk of the monopoly rents being extracted from consumers, and making the market more competitive would return these benefits to consumers.
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