Appendix C: Broad Policy Approaches
As explained in the body of the text, the set of broad policy approaches may be characterised by two dimensions: price restraints and/or ownership restraints. The presence of vertical integration expands the range of policy instruments compared to the non-integrated monopoly, as these restraints can be imposed at different functional levels. For example, price restraint may be imposed only on the natural monopoly component (i.e., on the 'essential input'); and/or on the final product of the vertically integrated firm. Similarly, ownership restraints may be imposed only on the natural monopoly component or on the entire integrated firm.
The broad policy approaches are summarised in Table 1.
These policy approaches can be placed into two categories: those that permit competition in the competitive part of the industry, and those that do not. The policies that do not permit competition are not discussed here although they may be the preferred options in certain circumstances. The remaining policies all involve competition of some kind. These policy approaches are now discussed further:
Approach (a): State Ownership of the Natural Monopoly Component
Rather than state ownership of the entire network (as was common until relatively recently), it may be preferable to restrict state ownership to only the natural monopoly component. By permitting firms to have access on non-discriminatory terms, competition can be introduced in up- and downstream markets without having to worry about market foreclosure problems. This allows consumers to benefit from competitive forces in the contestable portion of the network and limits the undesirable side-effects of state ownership to the natural monopoly component alone.
However, the undesirable side-effects of state ownership (i.e., inflated costs, lack of investment, slow introduction of new technologies) remain. In many cases these side-effects will be sufficiently large to rival the welfare losses from unregulated monopoly power.
Approach (b): Joint Ownership of the Natural Monopoly Component
If there are relatively few downstream firms, it may be possible for them to coordinate to jointly own the natural monopoly facility. In this circumstance, the incentives on the monopoly facility to exercise its monopoly power is significantly limited.
Problems arise, however, when a new entrant wishes to enter the downstream market. The existing firms have strong incentives to cooperate to act as a vertically-integrated monopolist would and foreclose the downstream market.
Also, the coordination necessary to cooperate in the operation and maintenance of the facility may facilitate collusion in the downstream market, to the detriment of consumers.
Table 1: The Broad Policy Approaches Grid
| | No Price Restraints | Intermediate Price Restraints Only | Final Price Restraints Only | Both Intermediate and Final Price Restraints |
|---|
| State ownership of vertically integrated firm | | | NZ Telecom before 1989 (price restraints implicit) | Australian telecommunications industry |
|---|
| State ownership of natural monopoly component only | | NZ Trans Power (price restraints implicit) NZ Airports Option (a) | | |
|---|
| Joint ownership of natural monopoly component by competing firms | Option (b) | Airline Computerised Reservation Systems | | |
|---|
| Enforced separation of ownership of natural monopoly | | US telecommunications industry after 1984 Option (c) | | |
|---|
| No restraints on ownership | | NZ Telecom, Gas trans-mission and Gas and Electricity distribution Option (d) [122] | US telecommunications industry before 1984 | UK telecommunications industry? Option (e) |
|---|
Approach (c): Enforced Separation of Ownership with Price Restraints on the Essential Input
In contrast to extensive regulation of the entire integrated monopolist, it may be preferable to encourage competition in those parts of the industry in which competition is feasible. This can be achieved by separating out the natural monopoly component of the industry and forbidding the monopolist to integrate back into the related market.
This option was chosen for the telecommunications industry in the US. The regional Bell operating companies were separated out from the old AT&T, forbidden from operating in the long-distance market[123] and subject to traditional rate-of-return regulation.
This approach restricts the inefficiencies of regulation to just the natural monopoly component of the industry.[124] However, determination of the scope of the natural monopoly component is difficult and likely to change over time. Important economies of scale or scope may be lost.
In addition, carefully drafted rules to prevent indirect ownership would need to be prepared and these could become quite complex. Special legislation would be required and significant investor uncertainty could be expected to result.
Approach (d): No Restraints on Ownership with Price Restraints on the Essential Input
This option has the advantage of requiring significantly less regulatory intervention than the previous options. The regulatory intervention is focussed upon fixing the interconnection price and no more.
Regulating the interconnection price, may introduce the inefficiencies associated with regulation discussed in the text. As mentioned above, regulators seldom achieve fully efficient outcomes. Lack of information, lack of incentives and lack of political oversight may hinder the achievement of the goal of economic efficiency whatever the institutional form of the regulatory body.
If the correct access price can be set with a minimum of regulatory involvement and opportunity for distortion (a strong condition), this option might be the preferred option.
Approach (e): No Ownership Restraints with Price Restraints on both the Essential Input and the Final Product
This option has been chosen in by governments in some jurisdictions (such as in the UK telecommunications industry) which have chosen to not break up an incumbent monopoly, but wish to achieve competition in the contestable component of the network. Introducing competition may ameliorate the inefficiencies arising from regulation and contribute to the advantages described above.
If the final prices are set 'correctly', competition cannot improve allocative efficiency, so the role of competition is limited to enhancing productive efficiency (as discussed above). In this context the sole objective of regulating the access prices is to discourage inefficient entry. This becomes particularly important if regulated final prices reflect distortions (perhaps reflecting social objectives such as universal service). In these circumstances, (putting aside any dynamic productive efficiency benefits) the appropriate access prices are given by the Efficient Component Pricing Rule.
If, for some reason, regulating the interconnection price (beyond the ECPR) is infeasible or unlikely to be efficient and if regulation of the final product prices is simple and likely to be efficient (a strong condition) this might be the preferred option.
Back to Top