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Kenya State-Owned Enterprises

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Kenya State-Owned Enterprises

The contestable markets hypothesis

The theory of contestable markets premises on the fact that a few firms in a given

industry do not translate to a monopoly when barriers to entry into or exit from a market

segment do not exist. These barriers are due to the cost-demand asymmetries situations of the

old versus new companies in a market segment. The situation, in turn, depends on the

incidences of sunk cost, which plays a considerable role in a new firm's entry or an old firm's

exit from an existing market.

The theory of contestability focuses on the scenario where a company can redeem its

initial investments in terms of marketing, reputation, and capacity upon exiting a market

(Brock, 1983). According to Yarrow (1986), even a firm that monopolized the sector will not

earn extraordinary profits under these circumstances because of the high risks of

opportunistic market entrants which would opt to exit the market as soon as the prices,

surpass the average cost, fall unfavorably. Therefore, the outcome of the scenario appeals to

the promoters of the privatization of monopolistic SOE. To this effect, if governments can

make markets more contestable the inefficiencies associated with market power would be

addressed.

Contestability theory has its shortcomings. Yarrow (1986) claims that the restrictions

on cost functions essential for a contestable equilibrium are rather harsh, such that the

existence of a contestable equilibrium is impossible in the majority of market segments. For

example, in sectors characterized by U-shaped cost graphs, new investors will displace

enterprises producing at high costs or realizing minimal profits. However, if companies are

manufacturing at low costs per unit output and not generating profits or losses, the market

will meet all the demand on condition that the demand over the level of the output reduces
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the cost of producing a unit of output and yields an integer value, which is often unlikely

(Yarrow, 1986).

The other problem with the theory stems from the fact that finding an economic

activity devoid of sunk costs, which the efficiency outcome of the theory is dependent on, is

extremely improbable. In addition, even a slight deviation from contestability can critically

change the contestability equilibrium properties. Therefore, if competition forces prices down

below or equal to the variable cost of a unit output, any amount of sunk cost incurred upon

entry into the market would deter potential competitors, allowing the existing firms to

monopolize the market.

Austrian Theory

Economists who subscribe to the Austrian school of thought believe monopolistic

behavior will often characterize market segments. As such, firms view supernormal profits as

a primary indicator of a robust market process, which serves as catalysts for discovering and

incorporating commercial information (Yarrow, 1986). For this reason, the Austrian tradition

emphasizes the competition for monopoly status attained through superior market

performance in non-price competition spheres.

Based on this theory, free access to rivals' information would facilitate a quick entry

of new firms into the market will eliminate the incentive for the discovery of new knowledge.

Therefore, entry restriction of any form at the production phase of the competition is crucial

to avoid inefficient outcomes. To this end, suck costs and other possibilities as patent and

copyright protection exist. As suck sunk cost promotes positive results from privatizing SOE.

Like contestability theory, the Austrian hypothesis suggests that SOE can be

privatized without consideration of the negative effects of market power. Nevertheless,

experts should be cautious when applying the principles of this theory for two major reasons.

This theory depends significantly on the freedom of market entry of new firms at the pre-
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production phases of competition. As a result, new firms planning to enter into a new market

after privatization must have equal opportunities for innovation as their incumbent

counterparts. If incumbents enjoy better cost competencies with respect to acquiring new

knowledge than potential market entrants, the situation would impede entry into the pre-

production phase of the competitive process and reduce the incentive for technological

advances for the old and the new firms respectively. Similarly, high barriers to entry into the

segment at the production phase impede entry at the earlier stage of the competitive process.

A new organization with the potential of developing a superior technology in terms of cost

efficiency, at a cheaper cost per unit produced than an incumbent firm may be discouraged to

venture into the market if it expects profitable production to be stringent.

Chicago Theory of Privatization

Regulations in any market seek to protect public interests against monopolistic firms.

Although this outcome represents the main goal of the privatization of SOE, the stakeholders

should not assume that regulatory policy and agencies will strictly align with the

predetermined rules and regulations. Notably, the challenges of monitoring the performance

in its stewardship of SOE constitute the primary shortfall of public ownership.

Chicago school of thought argues that politicians determine regulations in response to

the demands of different interest groups including the companies operating in the industry

(Yarrow, 1986). The stakeholders must supply the incentives first to the politicians to

establish the institutions and regulations, and later to those who implement the policies

developed by the former. The stakeholders provide incentives through different side

payments including political funding, votes, or future employment.

Chicago theory stresses the vulnerability of regulatory agencies to capture by a

specific interest group or groups. For example, Safaricom a telecommunication firm in Kenya

has monopolized the industry charging exorbitant prices for their services amid widespread
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claims of fraud by customers (Wafula, 2021). In some areas where the coverage of other

networks is small, the public has no option but to use the services of the company. In this

case, privatization allows for the exploitation of consumers. Based on the Chicago theory of

regulation, the threat result from a small number of regulators who can overcome the free-

rider issues attributable to collective action. However, much of the issue is due to the specific

institutional arrangements, which may favor monopolistic firms like Safaricom. Initially,

telecommunication was an SOE, as was broadcasting media.

References

Brock, W. A. (1983). Contestable Markets and the Theory of Industry Structure: A Review

Article. Journal of Political Economy, 91(6), 1055–1066.

http://www.jstor.org/stable/1831204

Wafula, P. (2021). Kenya: Rivals gnaw at Safaricom’s market hold. Daily Nation.

https://allafrica.com/stories/202104210060.html

Yarrow, G. (1986). Privatization. Economic policy. https://www.jstor.org/stable/1344560

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