1. Regulation vs. Competition in network industries Some lessons from the developing countries experience Antonio Estache July 2008

2. 2 Overview Some stylized facts Some theory tainted by facts Some case studies Some lessons Note: builds on joint work with Claude Crampes (Toulouse)

3. 3 Network Industries Focus on infrastructure –Telecommunications –Energy - power and gas –Transport - roads, rail, ports, airports –Water and sanitation

4. 4 The Initial Conditions in Early 1990s –poor service in terms of quality (Costly, high frequency of interruptions, …) coverage (rich connect. pay ) –no client orientation: no metering poor bill collection habits –political interference with tariff and clientelism –fiscal constraint : Tradition of soft budget constraints and high subsidies levels but …massive fiscal crisis => no more gvt financing: DRIVING FORCE FOR REFORM!

5. 5 Restructuring and PPPs as the solution? Search for fiscal benefits Search fo Improved Efficiency Improved Access and Affordability ?

6. 6 …: increased in the role of the private sector but not as much as often claimed…(% of countries with Private Participation) Elec.Gn.Elec.Dis.W&SRailTelecm SS Africa39%28%20%47%41% East Asia67%20%64%43%38% East. Europe41%48%62%20%58% Lat. & Cent. Am. 68%61%41%56%67% Mid. East7%6%18%20%23% South Asia38%13% 17%50% Developed70%43%80%65%83%

7. 7 Realizing the Benefits from Reform Form and extent of private involvement Market structure and competition Regulatory approach 3 drivers with interest to both regulation and competition agencies

8. 8 Search for competition as the main driver of restructuring?? Major unbundling efforts to promote Competition in the Market, –Removing unnecessary regulatory barriers to entry…and exit –Unbundling potential competitive activities from monopolistic activities (vertically and horizontally) Major effort to promote competition for the market, –Competitive bidding for new projects and privatizations –Competitive re-bidding at the end of concession/license terms Some effort to introduce formal and informal yardstick competition –Mexican ports, Brazilian railways, Argentina and Brazil water, various countries in electricity distribution ….But still many segments with strong residual monopoly power…so strong demand for regulation …and regulatory agencies

9. 9 % of countries with Independent Regulatory Agency -per geographical regions, 2004 -- Elect.W&SRailTelecm SS Africa34%12%3%75% East Asia36%25%0%19% East. Europe78%20%0%59% Lat & Cent. Am.73%50%28%73% Mid. East7%0% 59% South Asia50%n.a.0%75% Developed92%20%21%55%

10. 10 So what do we know in a nutshell? Not that many regulatory agencies –Strong regional biases –Both types of agencies are present in Central and South America –More regulation than competition in Africa –More competition than regulation in Asia –About even in Eastern Europe –Strong sectoral biases –In favor of telecoms and energy –Which means that self and hence political regulation continues to be widespread...and not a perfect coverage for competition agencies –OK in Latin America, Asia, possibly Eastern Europe almost absent in Africa –Economists matter relatively more in Latin America (+/-even with lawyers), much less in Asia (administrative staff dominates) and Lawyers dominate in Eastern Europe (the Serebrisky survey) –….and staffing biases drive the nature of decisions (economic vs political) And when network industries are covered by competition agencies…. –Bigger deal in LAC, then EE and much less in Asia –Moreover, politics matter a lot

11. 11 Moving a bit towards theory How to think about the differences in role for the regulation and competition agency that resonates with the real world…focusing on developing countries… but not completely irrelevant for developed countries???....

12. 12 Think of the degree of competition as the driving force in a continuum of forms of involvement of government Central planning Laisser faire Administrative regulation Competition policy

13. 13 Main differences in focus between regulation and competition agencies …The two types of agencies tend to focus on industries with different technologies marginal cost average cost q For segments of industry potentially competitive antitrust Marginal cost Average cost q For segments of industry potentially non competitive regulation

14. 14 Often there is a hierarchy and political and legalistic competition agencies prevail over (less political and « economistic » regulatory agencies Firm vs firm Firm vs regulatory agency Competition agency (or public authority performing that role)

15. 15 Where do problems come from??? The incompatibility of acceptable instruments of analysis and of solutions Economics vs legal instruments –efficiency vs. equity Biased arbitrations –Regulation in favor of benchmarking –Competition policy in favor of jurisprudence

16. 16 pMpM qMqM qCqC c p(q) R'(q) price 0 quantity ¿back to basics….why is it again that we worry about regulating monopolies???

17. 17 qcqc q3q3 q2q2 q1q1 Economists would be happy to support price discrimination…. 0 quantity price c p(q) p0p0 p1p1 p2p2 p3p3 High political costs and risks…. rent goes to monopoly buyers pay different pricess inconsistent with popular concepts of equity, social justice, public service…

18. 18 Lawyers and politicians prefer …price reduction c p(q) pMpM price quantity 0 Excess demand Problem… : rationing price loses its signaling value unacceptable from an efficiency and possibly social viewpoint...

19. 19 The disagreements on the design of prices is not the only problem we see Many competition agencies are revealing a bias in favor of processes and structural solutions… –=> questioning of some of the restructuring processes of the 1990s Most regulators tended to favor behavior and technical assessments (but this is changing…) –=> questioning some of the changes in market structure taking place since reforms (mergers, alliances,….)

20. 20 Legalistic and administrative tools Antitrust focus on: –market –relevant market –Market share and Herfindhal –abuse of dominant position –Agreement and restrictive practices –Concentrations –Subsidies levels and other state aid Regulation focus on: – industry –Vertical integration –Margins, cost of capital and Lerner Index –Price control –Quality control –Incentive to invest –Subsidies design –Accounting information (cost allocation, regulatory accounting…)

21. 21 Common issue in developing countries: access prices and rules Of common interest to regulatory and competition agencies "essential facility": access necessary to allow competition If vertical unbundling, simple natural monopoly problem If maintain vertical integration, suspicions of favoritism –So need information and access tariffs –Major drama….most reformed railways have faced the problem in Latin America for instance So how did countries deal with it??? –Legalistic-political vs economic solutions

22. 22 A quick review of decisions taken suggests that the main concerns are ( in no particular order…): Allow cost recovery and efficient production and consumption of product, But also…be equitable and not discriminatory, Send reliable signals for investment plans Stimulate entry of efficient producers and exit of inefficient ones, Be simple and verifiable Be polítically acceptable. Political solutions to access pricing

23. 23 A quick review of decisions taken suggest that the main concerns are (in a clear order!!) … objective: maximize collective/social surplus subject to the following constraints budget constraint/balance (~ participation) no discrimination (~ equity) information asymmetry (~ incentive) etc. Economic (normative) view of access tariff (more common in regulatory agencies)

24. 24 More generally: differing strategic visions RegulationCompetition ex ante contracts Common conflicts between USO, efficiency and budget balance Self selection process due to information assymmetries which result in: –Fixed applications of instruments, sometimes blind to specific situations –Tolerance for rents to more efficient producers as long as effort is not distorted –Lack of rent but tolerance for distortions in efforts for les efficient producers. ex ante law but ex post process exception: mergers authorization Same law for everyone –…but interpretations sometimes vague (still need guidelines) –Lots of case by case (rule of reason) without clear focus on efficiency –Signifiant rents for lawyers… –Conflicts btw competition and industrial policy (see Argentina post crisis)

25. 25 Practical cases focusing on need to see investments speed up…(coverage issue is central in LDCs!) Mexico: rail-port integration –modal integration or competition issues…? –regulators sees the financing of investment side –Competition see perverse integration –Transport secretary sees positive integration Chile: electricity production-transmission integration Brazil: freight-passengers rail interactions involving various government levels decisions Argentina: ports terminal mergers Africa and South Asia: fixed-mobile telecoms integration

26. 26 So… Experience suggests that many of the problems/biases of the OECD countries are being imported in developing and transition economies Major gap is still real concern for consumers…often more a battle between the state and the firms or btw the firms Major concern is that political power interference continues to be much more dramatic in developing economies

27. 27 Revisiting what happened to the these Initial Conditions of Early 1990s … –improved service in terms of quality (Costly, high frequency of interruptions, …) coverage improvement but often regressive improvements –more client orientation: But selective improvement…poor still face major problems –political interference never really stopped –fiscal constraint: Improved in short run…but gvt driven renegotitions often brought back subsidies…=> return of gvt financing!!!

28. 28 …BUT the real new issue is a supranational one…. concentration at the regional level…. and not enough people are really looking into that ElectricityTelecomsW & S GenerationDistributionFixedMobileWaterSanitation Global (inc. OECD) Prob. Not Prob. Yes Prob. Not Prob. Yes Prob. Not Africa Prob. Not Prob. Yes YES Prob. Not Asia & Oceania Prob. Not Prob. Yes Prob. Not Latin America YESProb. YesYES Prob. Yes Prob. Not North Africa NOn.a.Prob. Not YES Prob. Yes Eastern Europe NO YES Prob. Yes Prob. Not Prob. Yes

29. 29 Conclusions As usual…things are not always what they were intended to be Common focus but differences in instruments between the two types of agencies raise issues with some concern for users and taxpayers Politics matter increasingly and in that game competition agencies do better and are easier to recapture within a ministry Moreover, lots of things are happening at the supranational level Case for international cooperation is growing but…willingness to cooperate is still more formal than real As always…a big chunk of the incidence is on the poorest who dont see their access improve fast, but see affordability erode When their voice is only heard in crisis situations, the good of reforms in these sectors is increasingly thrown away with the bad… (see policy reversals in Latin America and Africa) Probably for the worse and not for the better…but we dont have the right counterfactuals…so we dont really know