Economists raise concerns over deregulation

They don’t build them like this any more Keystone

Switzerland could face serious economic and political consequences if it fails to comply with European Union demands to open up key industries to competition.

But experts are warning that, if it is not done properly, market deregulation might end up doing more harm than good.

Those were two of the key findings of a workshop in Zurich, “Incentive Regulation in Network Industries”, which brought together leading businessmen, academics and government representatives.

“Network” industries are industries such as telecoms, electricity or public transport that are based on common infrastructure – i.e. power grids or railways.

Politicians today are keen to open them to competition, but face the tricky problem of how to do so without uselessly duplicating resources that are effectively “natural monopolies”.

Trailing the neighbours

Aymo Brunetti, chief economist at the State Secretariat for Economic Affairs (Seco), said Switzerland was “seriously trailing” its European neighbours when it came to the liberalisation of key network industries, despite relative progress in the telecommunications field.

Brunetti said action was needed now to encourage more market competition – the key not only to lower prices for customers, but also to promoting long-term innovation.

He added that Switzerland “is not an island” and risked “discriminatory” measures by its EU neighbours if it failed to liberalise its network industries.

For instance, there was a growing risk that EU countries might act against Swiss power companies by denying them access to key national markets unless they offered equivalent rights to EU companies in Switzerland.

However, Brunetti also stressed the importance of offering the right “incentives” to key industry players.

He told the meeting that some methods used by many countries in the past – for instance, so-called “profit regulation” or “cost-plus” approaches – offered few, or even faulty incentives.

One promising new approach was so-called “yardstick competition”, which involves breaking up companies with natural monopolies into different firms serving different regions.

While each firm effectively retains a regional monopoly, regulators can compare results – prices, productivity, etc – and use them to put pressure on poor performers.

Regulatory paradox

Matthias Finger, a professor at Lausanne’s Federal Institute of Technology (EPFL), said the paradox of deregulation in such industries was that it needed substantial “re-regulation” to make it work.

Finger, who specialises in network industry management, said opening markets without also ensuring appropriate re-regulation could “damage the integrity and long-term viability of systems”.

For instance, new regulatory intervention was needed to guarantee network maintenance and security of supply, as well as to encourage long-term investment and innovation.

A good example was the blackout that affected most of Italy in 2003, which sparked claims that power companies in competitive markets were no longer prepared to invest in maintaining distribution grids.

Another crucial consideration was the so-called “universal service guarantee” – an issue often seized on by opponents of deregulation in the power and postal services sectors particularly.

Finger said the key was to ensure that regulators offered incentives to “encourage appropriate behaviour” – for instance, direct or indirect financial rewards for investing in new infrastructure.

Limited exemptions?

Lawyer Stefan Rechsteiner, a specialist in the power sector, said EU electricity market liberalisation provided a good example of “faulty incentives”.

Deregulation meant forcing owners and operators of existing power grids to offer access to competitors, with regulators determining both conditions and prices.

However, such legislation to ensure third-party access rights represented a “significant legal infringement” of existing property rights.

Rechsteiner argued that third-party access legislation in its current form risked deterring companies from major investments in future infrastructure development.

It was quite possible, he said, that today’s Europe-wide power grids would never have been built under free market conditions, as there would not have been any incentive for investors.

One possible solution would be to allow – time-limited – exceptions to the third-party access rule for new infrastructure investments.

Such exceptions would give operators much greater incentive to invest in new infrastructure – not just in the power sector but, for instance, in high-speed data communications networks.

Investments could then be made on the basis that there would be a sufficient “window of opportunity” to recuperate money invested – and to make a healthy profit.

After a set period of time, investors would then be forced to open up the new network to competitors – and to start thinking about where to reinvest their profits.

swissinfo, Chris Lewis

Key facts

Network industries such as electricity, telecoms and public transport represent a major part of the Swiss economy.
As in many countries, efforts are being made to promote competition and lower prices through deregulation.
However, experts disagree on the best way of doing this in sectors characterised by what economists call “natural monopolies”.

In brief

Participants agreed that market opening brings short-term benefits in the form of increased competition and lower prices.

However, deregulation could result in instability (i.e. power cuts) if regulators failed to take appropriate actions today.

Appropriate “incentives” are also needed to encourage future infrastructure investment and innovation.