Indirect taxes

Indirect taxes, namely VAT and customs and excise duties, can be used to influence the price and quantity traded of selected goods and services. A tax additional to the price of a product can be regarded as a cost and therefore shift the supply curve upward by the amount of the tax.

Imposing a tax on a product does not necessarily mean that the price of that product will be raised by the full amount of the tax. This is because producers might reduce their own prices so that the after-tax price does not discourage consumers from buying their products. Clearly, in this way the tax is a cost to producers because it will reduce their sales revenues and profits.

Tariffs and quotas

Tariffs are taxes placed on the price of selected goods and services imported from overseas in order to discourage their consumption and hence reduce a balance of payments deficit. A quota is a physical limit on the amount of goods that can be imported from overseas.

Subsidies

Subsidies are grants of money or tax allowances provided by the government to selected organizations to protect production and jobs and, in some cases, to keep prices low.

Subsidies are often paid to loss-making activities. If these subsidies were not paid, either the prices of some goods and services would have to rise or business organizations producing them would be closed.

New firms and industries in their infant age often find it difficult to start up and compete with well-established, larger foreign competitors. It is sometimes thought that these industries should be protected from competition from cheap foreign imports. The problem is that protected firms and industries never learn how to compete with stronger rivals and soon grow dependent on the protection offered and rarely succeed.

Governments can provide aid to business organizations in those parts of their countries which are designated as development areas in an attempt to regenerate employment, incomes, and demand in areas of industrial decline. The availability of regional grants may influence the location decisions of new firms.

There are also structural funds to contribute towards the cost of actions to deal with structural economic problems in the areas:

• lagging behind

• of industrial decline

• with long-term unemployment

• helping workers to adapt to industrial change

• assisting the adjustment of agricultural structures

• of rural development

Subsidies might also be used to encourage more environmentally friendly activities, for example, by subsidizing the construction of recycling facilities and plants.

Legislation and regulation

A number of laws exist to protect consumers from unfair and anti-competitive trading and to safeguard the environment from abuse by business.

Underpinning government competition policy is a view that anti-competitive and restrictive behaviour by dominant firms in markets is against consumers' interests. Legislation and government action to increase the degree of competition in markets has, therefore, aimed to control monopolies and mergers.

Merger activity refers to all forms of amalgamation between firms. Amalgamation occurs when two or more firms join together to form a larger enterprise. There are two main ways business amalgamation can take place: takeover or merger.

A takeover occurs when one company buys control of another through the acquisition of shares in the ownership of that company. Takeovers can be hostile or friendly. A hostile takeover occurs when managers and shareholders in a company resist another firm's bid for ownership. This will normally require the predator company to raise additional funds to purchase ownership. A friendly takeover occurs when one firms invites or allows another to take control. This may be because the firm cannot raise the necessary finance to expand or is struggling to survive in a competitive market.

A merger occurs when two or more firms agree to join together to form a new enterprise with a new legal (id)entity. This is usually done by shareholders of the merging companies exchanging their existing shares for new shares in the organization. The name of the newly created enterprise will normally reflect the names of the merging companies.

The main reason for amalgamation between two or more organizations is to expand market share and increase market power. Other reasons for mergers may include:

• to enter a new market, for example, in the form of a joint venture

• to defend market position by warning off competition or countering the threat of a hostile takeover by a rival

• to secure the supply chain by merging with a supplier

• to enjoy economies of large scale production

• for the purpose of asset stripping, i.e. buying another company at a market value which is less than the value of its total assets. The asset stripper will then close down any loss-making operations and sell off the more lucrative parts of the acquired firm at a profit.

A merger or takeover falls within the scope of legislation if it results in a combined market share exceeding an allowed value, or if the gross value of combined assets is over a certain value (25%, or 30 million pounds in the UK, for example).

Other laws deal with consumer protection. A number of organizations exist to advise consumers and protect their interests from large powerful producers who may be tempted to misinform or be economical with the truth. A large number of laws exist relating to safety, price, advertising messages, choice, and quality of goods and services. The basis of the law relating to the sale and advertising of products has now changed from ‘let the buyer beware’ to ‘let the seller beware’.

A vast array of rules and regulations apply to business activities, from the conditions in licenses for public houses and taxies, to shop opening hours, health, safety, and environmental standards. Some of the regulations are clearly out of date and need to be replaced, whereas others are thought to be too restrictive and reduce the competitiveness of the firms.

Laws have been passed which make it illegal to pollute the environment. They set limits on the type and amount of pollutants firms can discharge into the atmosphere, soil, and water. Many firms are now voluntarily developing their own codes of practice regarding the environment due to pressure in the market from consumers.

Public ownership and privatisation

The governments of different countries have in the past taken into public ownership entire industries for the following reasons:

• To promote economies of scale. Economies of scale refer to cost saving associated with large-scale production. Some industries need to be very large, even to the extent that they become a monopoly supplier, in order to take full advantage of the cost savings large-scale production can bring.

• To control natural monopolies and avoid wasteful duplication. A firm is a natural monopoly if the most efficient size of that firm is one that supplies the whole market. In a natural monopoly resources can be combined in the most productive and cost-effective way. In private hands such a large firm may abuse its market power to push up prices to consumers.

• For safety. Some industries, such as nuclear energy, were thought to be too dangerous to be controlled by private entrepreneurs.

• To protect employment. Some firms could be nationalized because they faced closure as private sector loss-making organizations.

• To maintain public services. Under public ownership, loss-making services, such as rail lines and postal services in remote areas, or supplies of gas or electricity to households that consume very little, can be subsidized using tax revenues.

Privatisation involves private firms taking over public sector activities. It can take many forms:

• The sale of public sector assets. Shares owned by the government in industries are totally or partially sold to the general public and private sector firms.

• Joint ventures with the private sector.

• Contracting out. Many local authorities invite private sector firms to compete for jobs such as parking enforcement, school catering, and road sweeping. This is known as tendering. Contracts are awarded on the basis of a private firm providing a low-price, quality service.

• Franchising. Purchase of a franchise to run a service or supply a product for an agreed period of time will be subject to certain conditions concerning minimum service levels, quality standards, and other requirements.

• Deregulation. Deregulation does not involve a transfer of ownership between the public and private sector. It refers to the removal of state controls limiting competition in markets. An example is the provision of bus and taxi services, which are now free to be provided by private operators.

Arguments for privatisation

• To stop government abuse of monopoly power. It has been argued that governments have in the past simply raised prices to fund increases in public expenditure.

• To increase efficiency. It has been argued that public sector activities were inefficient and provided poor services because they faced no competition and did not have to return a profit.

• To raise government revenue.

• To give ownership to the people. People have been encouraged to buy shares in the ownership of privatised industries. As shareholders, they have the right to vote on how these companies should be run and can earn dividends on their shares when these companies make profit.

Arguments against privatisation

• Competition breaks up economies of scale.

• The public interest is no longer protected.

• It does not return ownership to people. Instead, most shares in the ownership of privatised industries are held by large financial institutions such as banks and insurance companies’ funds. Many have also been snapped by foreign companies.

• Private monopolies exploit consumers. It has been argued that privatisation has created private sector monopolies able to restrict output to force up prices.