has in the past marked the airline industry. Such "problems" could in principle be "solved" by further extending the scope of present regulation, but the result would probably be even greater inefficiency and rigidity. All of which results from regulation of inherently competitive industries as if they were monopolies, with control of pricing, entry and to some extent, exit. Thus this justification is not appropriate as a basis for continued regulation of rates and entry in trucking or air transportation.

Competition should be allowed where feasible, and in many cases the regulated "monopolist" should be permitted, if not required, to respond by reducing prices but certainly no lower than to an incremental cost level. This would assure that regulated prices were not sustained at excessively high levels. As previously mentioned, the FCC has allowed such partial competition for leased microwave and long lines service. The ICC has not followed a similar course, much to the detriment of rail service.

Entry restrictions may be justified in a natural monopoly setting because the cost of duplicate facilities is, by its nature, excessive. If competition did exist it would tend to be short-lived. But attempts to enter may be indications that rates are excessively above cost or that the sector is not in fact a natural monopoly.

The possibility of monopoly output restrictions and excess profits does not mean that traditional rate of return regulation will yield net benefits. Rate proceedings will be costly to firms, and regulatory delay and uncertainty can increase risks and raise capital costs. Also, shielded from competition, regulated monopolies may become inefficient. Regulation which fixes the allowed rate of return above the cost of capital may induce excessive capital investment and raise costs.

This may have occurred in telecommunication, where AT&T appears to have shown a preference for relatively capital intensive alternatives, preferring to build rather than lease satellite circuits. To avoid this tendency, regulation should attempt not to reward a firm in proportion to its use of any particular input. Unfortunately, regulators have restricted the use of peak-load pricing, which could allow decreased investments capacity, and lowered rates, and inhibited the introduction of new technologies.

Indeed there is no definitive evidence that regulation has in fact constrained monopoly pricing. Moreover, the possible side effects of regulation indicate that alternatives may be desirable. Nationalization is one possibility, and in foreign countries has been applied to power generation, and transmission, transport, communications, and other sectors. In this country it could be an alternative to federal regulation of monopoly in oil and gas pipelines, some electricity transmission, and long-lines telecommunications. Yet the potential benefits from this are unclear. The efficiency record of public firms is uneven. The TVA can be cited in that regard as a success but many municipally owned electrical utilities appear to price relatively inefficiently by not recognizing cost differences in rates. Public ownership may also decrease output and raise prices to typical users. On the other hand the national British and French electric power systems appear to have been relatively efficient and innovative in peak-load and marginal cost pricing. Foreign nationalized railroads, still enjoying some degree of monopoly power,

have generally sustained losses perhaps in part due to excessive innovation resulting from easy access to capital at low cost. Nationalized firms may be subject to the imposition of special burdens, such as the requirement to purchase inefficient domestically made equipment imposed on the French telephone system. Lacking financial incentives to lower costs and increase output nationalized firms may be very

inefficient.

Even though the private and public airlines in Australia are constrained to be virtually identical in all visible ways, including equipment and scheduling, the privately run line has been more productive. Inefficiency may show up in lower costs combined with potentially lower quality output as may be the case with V.A. hospitals. Overall, it is doubtful that public enterprise would be an improvement on present monopoly regulation, and the record indicates that results could well be worse. Also to effectively control monopoly a federal chartering authority would require regulatory powers, thereby creating little real change in present conditions.

Another alternative would be to allow periodic competitive bidding for monopoly franchises, thus encouraging competition for the right to provide service and constraining costs and pricing discretion. If rate structures are complex or the product has many dimensions, choice of a provider may be very difficult. If capital equipment is very long lived-as in electricity distribution, franchises may necessarily be so long that incumbents will acquire insurmountable advantages over potential providers.

If contracts must recognize a wide range of economic and technical contingencies, some formal regulation will be required as well and potential providers will have incentives to attempt to gain entry by initial low-bid "bait and switch tactics". But bidding for franchises in cable TV (which is primarily regulated at the local level), combined with careful study of the bid proposals, can provide a check on cost and performance. One possibility would be to grant future licenses or certificates not in perpetuity but for a more limited period, and give government or government-selected "new" providers "buy out" rights according to pre-arranged terms. The risks of displacement might possibly raise the cost of capital, but incumbent's power could be lessened. Finally, direct subsidy could be used to induce monopolies to expand output. But that would conflict with the goal of reducing monopoly profits.

Alternatives aside, the overall extent of natural monopoly in regulated sectors is less than believed, because market growth and the appearance of substitutes have offset concentrating tendencies. Moreover, entry restriction and price regulation should not be absolute even in supposed "monopoly" sectors. Indeed, regulation should mandate increased peak load and other suitably "responsive" pricing. Some increased regulatory oversight of major capital expenditure programs could counter tendencies to undue rate-base expansion, though this should be done on a highly selective basis so as not to inhibit innovation. Franchise bidding combined with regulatory oversight of contracts should be given at least experimental trials, possibly in the field of cable television. Most importantly, potentially competive sectors such as airlines and trucking should not be regulated

as monopolies. Gradual and phased relaxation of both entry and price controls could lower costs and prices, and improve service quality with little risk of either monopoly excess or destructive competition. While natural monopoly can justify some form of public control, today's apparent monopoly can become tomorrow's workably competitive sector. And the opposite could also occur. This only lends strength to our general recommendation for thorough periodic review of regulatory performance and appropriateness.

2. Controls on price discrimination

Much Federal and state regulation generally has as a stated purpose the prevention of undue discrimination, in the sense of prohibiting different prices for similar services. For example, price discrimination between long and short hauls and in favor of large shippers were among the complaints leading to railroad regulation and establishment of the ICC. To be sure, price discrimination can unduly increase producer profits, at the expense of disfavored groups, and impede competition. However, perversely, regulation sometimes actually imposes or fosters discriminatory practices by regulated firms.. For example, first class postal rates, although uniform, do not reflect location and distance, and thereby may discriminate against users onhigh density routes or those sending letters short distances. Generally any regulatory approach which prevents relative costs and scarcity values from being reflected in rates or prices may be discriminatory.

In both the short and long run, cost-based price differences are necessary for efficiency. In the short run price variance may exist (as between regions) because of differential scarcity and resource immobility. Under competition these price differences will promote efficient patterns of production and consumption. Economic price discrimination-which charges different price-cost margins to various users as an exercise of monopoly power-can have good and bad effects. Monopoly profits will increase but the firm may expand output, thus reducing restrictions in that regard. This can lead to threatened entry into the high rate areas and demands for protection from entry. Discrimination can also competitively disadvantage payers of high rates. Selective or predatory price cutting and discrimination can be used by monopolies to destroy competition or deter entry. It can alsolead those subject to high rates to expend resources to gain access to the lower rate levels.

In many regulated sectors, it does not appear that discrimination is or could be a significant problem. For example, under present circumstances rail monopoly power is probably too slight for there to be much discrimination. So too, trucking is too flexible and atomisticfor there to be substantial monopoly power and discrimination without regulation. In a less regulated airline industry monopoly power on most routes would be slight and the ability to harmfully discriminate small. This leaves pipelines, telephone long lines and electricity ansmission lines, which could have enough monopoly power to make harmful discrimination a real possibility.

Preventing price differences can have negative effects, and imposing uniform prices when costs differ is itself discriminatory. Disallowing cost-justified rate differences can slow technical progress, as in the

transportation industries, where introduction of unit trains, larger hopper cars, and "piggy-back" service was slowed. To increase air carrier profits, the CAB-required discrimination in the form of enforced higher margins on long haul flights, inducing investment in the inefficient and rapidly obsolete DC-7. Had prices not been discriminatory and had fare discounts been offered on flights with stops, this wasteful investment would probably not have been made.

Prohibiting peak-load price differences (perhaps on the ground that they are viewed as discriminatory) can cause excessive investment in capacity and elevated rates. Charging uniform airport landing fees does not take account of actual costs of delay, congestion and increased risks of accident at peak hours; and may contribute to pressure for increased airport capacity, with resulting environmental impacts and greater demands for subsidy. "Nondiscrimination" in landing fees also heavily subsidizes general aviation users of busy airports, at the expense of other flyers, while yielding comparatively slight benefits to general aviation. Similar problems occur with "nondiscriminatory" highway tolls which, if constant over the day and week will not take account of the costs of congestion. In order to be efficient, rate or fee differences should take account of all the relevant cost differences whether the costs are visible or not, and not simply be based on the costs to producers of providing service. "User charges" equal to all will be discriminatory in effect if various users impose different social costs.

Imposing identical prices when costs differ may also cause deterioration in the higher cost service and may induce wasteful service competition to capture business in the high profit areas. The latter has clearly occurred in the CAB regulated airline industry though recent reform have reduced the problems.

As an alternate to regulation, public enterprise is one option for preventing undue discrimination, on the theory that government could achieve that purpose by simply setting appropriate rates. However that may not be as simple as it appears. For example, the United States Postal Service has continued heavy discrimination against first class users despite explicit legislative instructions and adverse court decisions. Moreover public enterprise may be more vulnerable than private firms to powerful pressures for special treatment. Also, if viewed as a source of revenue (as was the British Post Office) public ownership might in fact have strong tendencies to discriminiate to increase profits. Shielded from competition, they could do so even more rapaciously than private firms.

Overall, assuming the existence of a problem in need of remedy, regulation may be the best way to deal with undue discrimination. But that justification ought to be used sparingly, because whenever possible cost-justified differences should be allowed. Certainly, in competitive industries, there is little rationale for regulating price at all, much less price differences. Firms with market power in industries with entry barriers might engage in predation or anticompetitive selective price cutting, but such actions have been rare in unregulated industries.

Predatory discrimination may be more likely in regulated industries where entry is barred or limited, or where firms may have incentives to enter unprofitable markets to increase their rate bases and allowable

total profits. Telecommunications may be such an industry, but examples of predation are not apparent. Requiring that prices at least cover the direct costs of service sharply reduces the potential for predatory discrimination. Overall, then, a combination of some regulatory oversight of price structure, with elastic concepts of appropriate cost justification, appears desirable in those cases where substantial monopoly power exists. On the other hand, in competitive industries, there is no compelling reason to regulate price differences. Moreover, in such industries, price regulation is likely to be wasteful, costly and administratively burdensome.

3. Control of external effects

Compelling firms or individuals to consider the full consequences of their actions is without doubt a valid justification for some form of government intervention. As previously mentioned, the major thrust of present regulation is setting and enforcing standards, on the theory that by doing so firms and individuals as well as state and local governments will be forced to properly consider the costs of their actions and thereby control external effects. But, if standards go unenforced or sanctions are ineffective, the system will not work effectively. This may have been the case for FDA food plant inspections and OSHA safety inspections as well as some EPA programs. By their nature, standards appear to guarantee certainty of result. However, if the costs of complying are substantial in comparison to the costs of not complying, the result will be far from certain.

Regulation uses many types of standards, which fall into two major categories. "Performance standards" require certain achievements, such as particular emission levels, stopping distances, nutritional qualities, or levels of worker exposure to hazards. That type of standard allows firms and individuals to choose the least-cost method of compliance. This approach encourages flexibility and technical change, although extensive monitoring may be necessary to insure compliance. But if the standards are set without regard to compliance costs and potential consequences, undue burdens may be imposed. For example, Federal flood insurance regulations require all member communities to provide protection against the "100 year flood" however slight the potential hazard. On the other hand "specification standards" require particular means of achievement, such as specific design, equipment or techniques. Unlike performance standards, monitoring and enforcement can be less burdensome. Yet delineating specific means of achievement necessarily limits the range of technological change and may impose unnecessary costs. Flexibility is also lost, as firms and individuals are given little latitude to choose the least cost method of compliance. Despite its drawbacks, a standards-enforcement approach, is in certain circumstances justified. Specification standards in particular and standards in general are most appropriate when the risks from "noncompliance" are great-as in the case of dangers associated with nuclear reactors or when the consequences may be severe or irreversible, as with possible epidemic-causing diseases. Thus this approach has a certain viability.

However, unless carefully designed, standards may impose higher than necessary costs. That consequente could occur with standards