Regulatory options for the privatisation of natural monopolies with particular emphasis on the privatisation of Telecom in New Zealand

Abstract

The increased prominence of market thinking has seen many Governments liberalise markets that were previously tightly controlled by regulation. Similarly, these Governments have at the same time questioned their role in society. This questioning has seen them first commercialise and in some cases privatise previously publicly owned trading enterprises. All of these initiatives have had the objective of increasing the efficiency by which resources are allocated in the economy. Liberalisation was designed to promote pricing efficiencies, while commercialisation and privatisation were designed to promote production and investment efficiencies.

While the promotion of efficiency has been the key motivation behind these reforms, these same reforms provide the incentive for some industries to act inefficiently - especially those industries with natural monopoly characteristics. These characteristics mean that it is productively efficient for one firm rather than many to produce desired output. However, because only one firm can exist in a market, commercialisation and privatisation give that firm, in some cases, the ability to "inefficiently" price above cost. That same ability not only allows the monopolist to affect the operation of monopoly markets, but also "competitive" markets - especially if the monopolist operats in those markets - because refusing to supply product essential for operation, or engagin& in other forms of discrimination, would prevent competition. For these reasons Governments should consider regulating those industries.

When faced with the issue of regulation the first question a Government should ask is whether the monopolist can exploit. Obviously if the monopolist is threatened by entry - whether that be nationally by replication, or internationally by importation - or consumers can substitute or forgo the monopolist's product, then the monopolist does not have the power to exploit in any market. However, as entry barriers rise, and the dependency of customers increases, then the Government should consider regulation. Then the issue facing Government is not whether the monopolist can exploit, but the extent to which the monopolist can exploit. For example, if barriers to entry are slight or if consumers can substitute (albeit imperfectly) with another product, then this loss to society may not warrant the imposition of costly, less-than-perfect, regulation. In other words, imperfect competition will often provide greater benefits to society than will regulation designed to correct these imperfections. However, as these imperfections increase, so does the likelihood of regulation. Regulation will seek to maximise efficiency benefits to society. If Government decides to regulate, then it must choose between alternative regulatory policies. These policies are the subject of this thesis with evaluation based on two objectives.

First, any regulatory solution should seek to promote economic efficiency and secondly, that solution, where at all possible, should fit within the Government's framework of a liberalized "market" economy. These tools are then applied to the recently privatised Telecom Corporation of New Zealand. This application, and initial regulatory evaluation, are conducted within a public policy rather than economics based framework. Based on this reasoning I have split my thesis into three sections with each section subdivided into chapters. The first section deals with the issues of liberalisation, commercialisation, privatisation and natural monopolies. Chapter 1 discusses the reasons and motives for liberalisation, commercialisation, and privatisation. Chapter 2 extends this analysis by looking at the factors that will determine when a natural monopoly exists. This chapter also shows how such a monopoly can best promote productive, allocative and dynamic efficiencies. Finally, chapter 3 considers when Governments should use regulation to promote efficiency - assuming a perfect world. With this analysis in mind, section 2 attacks the issue of regulatory options. Chapter 4 considers the place that a threat to regulate has in the Government's regulatory armour and how such a threat can prevent both monopoly and competitive market exploitation. Chapter 5 examines the place of antitrust law within the Government's regulatory framework and how such law retains the principles of light-handed regulation, while controlling the monopolist's behaviour in competitive markets. Chapter 6 contemplates the issue of price control. This chapter discusses how Governments can use these controls to prevent exploitation in monopoly markets and, to a lesser extent, predation in competitive markets. Finally, chapter 7 looks at the issue of structural separation and how such separation can increase competitive pressure. Such separation can reduce the need for regulation. In section 3 I apply these regulatory tools to the telecommunications industry. Chapter 8 backgrounds the industry by considering its network characteristics; natural monopoly features; and the path Governments have taken to liberalise the industry in New Zealand, Britain, Australia, and the United States. Chapter 9 details the pricing issues within the industry and how a combination of light-handed controls, coupled with the threat of heavy-handed intervention, could effectively force cost based pricing. Chapter 10 deals with the important issue of industry competition and how a competitor must interconnect with the natural monopoly in order to compete. To ensure connection alternative regulatory options are considered. Chapter 11 then looks at how the monopolist can use other practices to engage in anti-competitive behaviour. This chapter looks at the mechanisms by which Governments could control these practices. Finally, chapter 12 summarises the findings of this section.