Industrial Structure and Monopoly Power in the Federal Bureaucracy: An Empirical Analysis

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INDUSTRIAL STRUCTURE AND MONOPOLY POWER IN THE FEDERAL BUREAUCRACY: AN EMPIRICAL ANALYSIS

I. INTRODUCTION

In theories of public supply of services, bureau monopoly power plays a key role in determining output, budget, and cost levels. That bureaus have considerable monopoly power has generally been taken for granted. (1)

Margolis [1975] and Kaufman [1976], however, question the validity of this assumption. They suggest that bureaus compete, not only in the broad sense of the "invisible hand" as proposed by McKean [1965], but also in the narrower economic sense of supplying substitutable services. Borcherding [1988] comments on "...the need to establish the strength and effectiveness of competition within the public sector..." in order to determine the role of competition in public sector resource allocation.

To date there has been no direct empirical test of the assertion that individual bureaus have monopoly power. This paper presents such a test by first estimating the industrial structure of the federal sector, and by next examining the relationship between measured industrial structure and bureau monopoly power.

This investigation is limited to estimating federal industrial structure, as distinct from market structure. That is, the characteristics of bureau supply are examined, but demand characteristics are not. This approach is consistent with the focus of most existing theories that rely on the assumption of monopoly power. These theories model bureaucratic managerial behavior in supply, taking the legislative role to be primarily one of production monitoring. (2)

II. MEASURING INDUSTRIAL STRUCTURE IN THE FEDERAL SECTOR

Most bureaus are considered as independent organizations analogous to the firm in the private sector. The concept of a public sector industry is also analogous to that of a private sector industry, that is, a collection of producing organizations that supply a similar service and then compete for funds. A private sector industry is considered to be highly structured if the distribution of market shares (or some other measure of size) of the firms in the industry is significantly uneven. (3) Two commonly accepted measures of the degree of industry structure in the private sector are the concentration ratio and the Herfindahl index.

Of the two measures, the concentration ratio is cited more frequently, primarily because it is readily available. The concentration ratio measures the combined market share of a given number (usually four or eight) of the largest firms in an industry. Because it is a partial and aggregate measure of industry structure, the concentration ratio provides limited information on the firms included in the ratio.

The Herfindahl index measures the dispersion of firm size within an industry by summing squared market shares of each firm. It is generally considered a better indicator of overall industry structure and competitive level within an industry than the concentration ratio because it usually incorporates information on market shares of all firms in an industry rather than overall concentration of a few large firms. The more limited use of the Herfindahl index may be attributed to its extensive data requirements.

Each of these measures is used to estimate industrial structure of the federal sector. To determine public sector industry structure, budget and expenditure data on federal funds (general and special funds) were obtained from the Budget of the United States Government, Appendix at the agency level for all bureaus active in either of two fiscal years, FY 1985 and FY 1980. (4,5) Data on nearly 300 federal organizations have been examined for each fiscal year. FY 1985 is the most recent fiscal year for which actual rather than estimated data are available. FY 1980 was chosen because a five-year interval should be reasonable for comparative purposes, and is consistent with the practice for similar calculations made for the private sector. …