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Dr. BAUMOL. But that is precisely what happens and sometimes you are rather mad.

Mr. CONTE. Well, I wouldn't go back to him.

Dr. BAUMOL. Maybe not. That is up to him. You see that may be poor business judgment on his part. He may indeed lose customers in the long run, if it does have that sort of reaction. I am not suggesting that every business decision that is made, every extra that is thrown in a car is good business judgment. People do make mistakes.

But again what I think you have helped to bring out is precisely the same sorts of things are observed as perfectly normal business practice in the unregulated areas of activity. But in any event I emphasize I am not here to defend any particular type of promotional practice. I am not in a position to do so, and I can say offhand that I am sure I could be shown some which I would not like.

What I am arguing is that the generic term "promotional practice” is not per se objectionable.

Mr. POTVIN. It is a neutral term.

Dr. BAUMOL. That just as there can be prices which are objectionable there can be promotional practices which are objectionable, but the criterion as far as cost is concerned must always be incremental cost, because, if you prevent a firm from selling any service at an incremental revenue which exceeds incremental cost, you are hurting all customers of the business, and not only the buyer of that particular item.

I have one more point to make and then I will hold my peace. This is the thing that I think really is of greatest concern of all to economists who view the regulatory field, the danger of protectionism in rate regulation.

As we view the history of regulation, we marvel at several things. No. 1 is the general goodness of the intentions of the whole operation. There is no question that regulation is necessary or that the regulators, by and large, are trying to achieve very valid objectives in trying to promote the social purpose. But that in the process, they have tended to adopt a type of control which has served to protect all individuals who are hurt so that in the process they have tended to stifle competition, and that is not what regulation is for.

The objective to this type of activity seems to be to protect the "form" of competition by protecting all firms at whatever social cost may be incurred. I would venture to suspect that, if buggy manufacturing and automotive production were both regulated, that buggy production might still be flourishing. Some way would have been found to keep automobile prices high as a means to protect the inherent advantages of the horse-drawn carriage.

But surely that is not the purpose of competition. The purpose of competition is to force efficiency on the individual firm, and I emphasize the word "force," and to keep prices low for the consumer.

Mr. POTVIN. Professor, you are not saying certainly that, if a buggy manufacturer and a car manufacturer each selling their wares, or let us say really a retail dealer would be more applicable, came to you and attempted to sell you their wares on the basis of the merit of the product, service, price, it is, I think, clear that the buggy people would meet with minimal success, isn't it?

Dr. BAUMOL. I daresay that, if the price of the car were made sufficiently high by regulation, as it might be, as I say, to protect

the

Mr. POTVIN. No, I mean in a free, unrestrained market.

Dr. BAUMOL. I said on the assumption that these were regulated activities.

Mr. POTVIN. For the purposes of this question, in a free unrestrained market it is clear that the force of competition having been unleased, that the buggy people on the basis of service, merit of product and service, would meet with minimal success in our present-day society. Dr. BAUMOL. Precisely.

Mr. POTVIN. So this realy is all that the opponents of this promotional thing have been saying. "Let us compete on the basis of merit of product, service, and price. Please do not allow people to buy clumps of customers so that even if our price is lower, even if our service is better, even if our smile is broader, we can't get into the market."

It seems to me that this would indicate that allowing to buy customers would redound far more to the advantage of the inferior product; that is, the buggy, than the automobile.

Dr. BAUMOL. Sir, what we see here is precisely the scream one sees every place as soon as competition begins to be hurt. We see this in the case of pure rate competition in other areas. I have seen enough cases where the competitor who is hurt screams that the price is too low.

Here the complaint is not about price but about another element of the spectrum of competitive practices.

The very complaints are signs that competition is effective. If they did not feel it, they would not be here complaining.

Mr. POTVIN. Well, of the tens of thousands of complaints received at the Federal Trade Commisison each year, for example, I take it they are all from competition of some sort. Some are from illegal competition.

Dr. BAUMOL. Sure.

Mr. POTVIN. Some are from predatory competition, some are from benign competition, proper, improper, and the whole spectrum. It seems to me that what you have said is undeniably true. I am just not sure that it means anything; does it?

Dr. STELZER. But I think there is a significant difference here. The tests, the complaints that are being received here are first of all complaints being received, and we have offered-have suggested tests against which they can be judged, just as the Federal Trade Commission has hammered out a set of tests that it would use to sort these things out.

Second, I judge from the various witnesses that these tests are in fact being applied in other tribunals, for example, Illinois and Connecticut. These tests are being applied in some cases to the benefit of one group, in some cases the other. So that it seems to me you have a somewhat different situation, when after application of these testswhich we think are proper-a contestant is dissatisfied with the findings of the tribunal and brings his complaint before yet another body. That is a different kind of complaint from those initiated before the Federal Trade Commission.

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Mr. POTVIN. Professor, one thing you have not addressed yourself to, that I think would be terribly helpful to us, is the role of the electric utilities. As an example, when GE picks up a mortgage or arranges financing, sells at reduced rates, that type of thing that is in the record. What comment would you have on that, sir, these of course not being under the State regulatory bodies are perhaps a more immediate function of potential Federal jurisdiction.

Dr. BAUMOL. Again I would have to know about the individual cases. I can think of examples where it might be legitimate; I can think of examples where it might not. If conspiracy were involved, obviously it would be highly undesirable. In other cases, where an individual firm on its own goes out and offers promotional advantages on its products, then this may be a perfectly legitimate business activity. That is, I just can't generalize.

Mr. CONTE. Professor, you speak about competition being healthy for the industry, and I agree with you, providing it drives the price down for the commodity or the product. I am all for that.

The proponents of Lincoln-Dickey use the same argument on behalf of their bill that you are using here. They say that if they build this powerplant in Maine, it will be competitive with private utilities in New England and drive the cost of utilities down. How do you feel about that?

Dr. BAUMOL. I see nothing inherently objectionable. Again I agree, and we did not collude on this answer, but I agree with Dr. Stelzer that it depends on a careful examination of the facts of the matter whether it is desirable. That is to say if indeed it turns out that public operation, when its costs are legitimately and carefully calculated, can provide the service to consumers more cheaply, I am all in favor of it.

Mr. CONTE. Have you had an opportunty to study this case?

Dr. BAUMOL. No, I have not, but I can say this: That there are very great dangers in careless cost computations which one sees in far too many cases of public enterprise. The 34-percent discount rate being used, for example, on waterway projects, is based on a totally fantastic sort of rationalization, when by any sort of reasonable calculation the true social cost of capital is well above 5 percent. This means that any project which is proposed and rationalized on a cost calculation based on that discount rate is bound to be an imposition on the public. But I see nothing wrong with the supply of power by public authorities, if in fact they can do it more cheaply and more efficiently. Mr. CONTE. We can't go into this. You haven't had an opportunity to study it in order to give your opinion whether the cost studies are good or bad.

Dr. BAUMOL. But there are many people competent to examine these things, and I would certainly hope that in fact people who have specialized in these matters are consulted.

Mr. CONTE. Like economists, you come up with two schools of thought, one by the proponents and one by the opposition. I thought you, as an impartial individual, perhaps had had an opportunity to look into this and could give me an off-the-cuff opinion.

Dr. BAUMOL. I think you would find that most members of my profession would take very similar views on the appropriate costs, on the appropriate discount rates, and so on.

Mr. POTVIN. Would you favor-one witness this morning from Congressman Conte's home State of Massachusetts said that in that jurisdiction what he does, and what I take to be a matter of requirement by the State regulatory body, is that on a given promotional payment they would not pay it to the builder or the installer, but it would go directly to the eventual ratepayer, the consumer if you will. Of those two approaches, paying to the builder who knows the possibility of a pass-through, or requiring that it swerve around him and be paid directly to the consumer, would you see any meaningful difference between those two approaches?

Dr. BAUMOL. Not terribly much. There is all sorts of experience suggesting that there is often an illusory difference between the two, you know, who pays the sales tax on a particular item. The fact is that if the seller pays the sales tax, the final price is adjusted to include it. If the consumer pays the sales tax, the final price is not adjusted, and whether we say it comes from the one or we say it comes from the other may in fact make very little difference.

Mr. POTVIN. Thank you.

Mr. CONTE. Continue, Professor.

Dr. BAUMOL. Yes. Well, as I was saying, economists are really deeply concerned about what has happened throughout the field of regulation, which has been a continued emphasis on protection as a means to preserve what appears to be competition, and that in the process what is lost is both the pressure for efficiency and the pressure for low prices. It is indeed a curious arrangement in which the consumer is allegedly protected by imposing on him high prices as it were for his own good, where in fact the criterion that is set for pricing forces firms to price above, well above, incremental costs, presumbaly for the maintenance of competition, because the net result is retention of the form of competition but the destruction of its substance.

Mr. POTVIN. Professor, we have had much this same problem in our hearings in the drug industry. Now, is it not a fact, sir, that in order to apply incremental costing or pricing, you have to have a rather substantial mass of customers that are not incrementally prices!? I can't open my shop and sell the first unit at incremental price, can I? Dr. BAUMOL. First of all, remember that we are talking about including in incremental cost the cost of capital and the rate of return on capital.

Mr. POTVIN. Yes. Your complete incremental cost is a bit different. Dr. BAUMOL. That is right. I am talking about complete incremental cost.

Mr. POTVIN. Yes, sir; but even so doesn't this still to a degree imply the presence of other customers that are not incremental costed in any form?

Dr. BAUMOL. Remember, I am not advocating prices equal to incremental cost. I am just saying that any other cost floor alone is an improper one.

Mr. POTVIN. You are not advocating that prices be at complete incremental cost?

Dr. BAUMOL. I am not advocating that prices should be at

Mr. POTVIN. But that they should approach as nearly as possible. Dr. BAUMOL. I would like that, certainly. In fact, the literature is full of that desire on the part of economists.

Mr. POTVIN. But nonetheless in any of these concepts, you have to have a mass of other customers on other bases to incremental costing, do you not?

Dr. BAUMOL. Yes, but the way you protect the first set of customers is by placing ceilings on their rates, not by placing artificial floors on the rates of the new customers.

Mr. POTVIN. Yes, but this is somewhat reminiscent of the fact that the retail druggist has to pay prices up here and other class pay prices for down here, and were it not for the thousands of retailers at the high price, there obviously could not be lower prices.

Dr. BAUMOL. But if you are concerned about the high prices the retailer is charging then do something about those prices. If after you have done something about those prices the manufacturer still finds it profitable to sell at a low price at this other end, fine.

Mr. POTVIN. Chairman Dingell keeps asking that question, why do you always wants to close the gap by bringing the one up rather than the other down?

Dr. BAUMOL. Yes. Whether a particular businessman likes it or not, I assure you that what I like is bringing the high price down, not forcing the low price up.

Mr. CONTE. I think that you have general concurrence on that.

Dr. BAUMOL. Very good. I am delighted. So what I am arguing against is a set of regulatory rules, which we do still see in many commissions, which preserve the competitors but destroy the process of competition which, allegedly to protect the customer by retaining the presence of competitors, in fact rob him of all the benefits he would get in the form of low prices through free and effective competition. As a profession we feel obligated to emphasize that protectionism in rate regulation must impose heavy costs upon society. It promotes inefficiency. It raises prices to customers, and produces misallocation. of resources. Let us not delude ourselves that public virtue resides in such a policy which by muzzling real and effective competition threatens the most basic qualities of our economy.

Mr. CONTE. Thank you, Professor.

Mr. GIBSON. We are very grateful to the committee for its patience and consideration, and trust that should there be any lingering doubts, that on reflection they will disappear.

Dr. BAUMOL. Thank you very much, Mr. Chairman.

Mr. CONTE. I want to thank you for the committee for your courtesy and for the wonderful presentation you have made here today. You were a very fine witness.

Dr. STELZER. You are very kind, sir.

Mr. CONTE. Mr. Madole, I understand you have a short presentation.

TESTIMONY OF TRACY MADOLE, EXECUTIVE VICE PRESIDENT, SOUTH BEND RANGE CORP., SOUTH BEND, IND.

Mr. MADOLE. Yes, sir. It should take about 10 minutes, I would think. My name is Tracy Madole.

I am executive vice president of South Bend Range Corp., South Bend, Ind., South Bend being a supplier of commercial gas appliances. I am appearing in response to your invitation to Mr. John Woolverton, president of our company, who was unable to be here today. I

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