4 Promoting appropriate regulatory and competitive frameworks
As discussed previously, the optimal benefits from restructuring are only realised when the markets in which the SOEs function are reorganised to promote competition. The expansion of markets internationally and technological advances create increasing opportunities for promoting competition, even in industries that were traditionally regarded as natural monopolies. For instance, in the energy sector, new technology has enabled competitive generation and distribution industries to develop, even where the network remains a public monopoly. Similarly, in telecommunications, new technologies are challenging the predominance of a single national network and are opening up the market to competition. Nevertheless, some areas in the economy will remain susceptible to non-competitive behaviour or to other market failures (such as negative externalities or the failure to incorporate public goods), and these will need to be addressed through some form of regulatory regime.
The establishment of a regulatory regime prior to the restructuring of a public monopoly has become standard practice in South Africa, and many such regulators now exist. Ministers at the IMCC Lekgotla expressed some concerns about the current practice. They believe that the proliferation of independent regulators is likely to grow as the restructuring programme is accelerated. They are particularly concerned that certain regulators have adopted a policy-making role independent of Government. Both the rapid increase of regulators and the lack of clarity about roles and responsibilities are seen to contribute to market uncertainty that could eventually undermine the achievement of the restructuring objectives.
The Ministers stated the need for establishing a common framework governing the functions, responsibilities and operations of regulatory authorities, and possibly for consolidating regulators in certain sectors. The question was raised whether the newly established Competitions Commission could not (as in the case of Australia) take over some, if not all, of the functions of individual sector-specific regulators. The Department of Trade and Industry and the Competitions Commission then undertook to provide some guidance on this issue.(1)
Competitions Commission and the Regulators
The new Competition Act, which came into force on 1 September 1999, creates an institutional framework for the regulation of mergers and the proscription of anticompetitive behaviour. These two areas are also, to varying degrees, the subject of the jurisdiction of various industry-specific or multisector regulators.
Jurisdictional conflict over which authority should regulate which area often, leads to tedious and expensive litigation over purely procedural matters, thus preventing regulators from engaging in substantive issues. Generally speaking, economic regulation is undertaken to control specific industries, markets and business practices, thus focusing on price, markets and the obligation of the industry has to provide the public with adequate service. The distinction between technical regulation and competition regulation is, however, often blurred. For example, technical decisions regarding spectrum use in the telecommunications sector and the accompanying decisions about licences profoundly affect the intensity of competition in the sector.
Competition authorities and regulatory agencies (be they industry--specific or multisectoral) can co-exist under various conditions, depending on their jurisdiction and mandate. Competition issues in a regulated sector may pose certain dilemmas, the outcome of which depends on how the allocation of jurisdiction in these matters is understood and the effectiveness of the agencies involved. Moreover, friction may exist regarding the prioritisation of objectives and the methods used by regulatory authorities and competition authorities.
Regulation is implemented as a substitute for competitive forces (by enforcing a price cap, for instance), whereas competition law is aimed at protecting and enhancing the competitive process (which will drive prices down) and to set boundaries for acceptable business conduct. Unlike regulation, competition law is not suited to protecting individual firms or sectors from competitive forces; rather, it is aimed at providing firms the opportunity to enter markets and at providing choices for consumers. The rationale for economic regulation is found in market failures that prevent socially optimum levels of production from being realised.
The objective of sector-specific regulation of certain industries is, therefore, to counteract market failures, such as externalities, monopoly power, the need to incorporate public goods, and information asymmetries. It is generally accepted that economic regulation is warranted in an industry where the competitive forces do not lead to optimal outcomes, be it for consumers, the environment or related domestic industries. However, due to the global trend towards the liberalisation of markets, as well as technological advances, the notion of what constitutes a natural monopoly, is constantly being eroded.
Regulation is often thought of only in terms of the establishment of preventative mechanisms for restraining unscrupulous business activity when competition is being introduced. However, it also incorporates measures for ensuring that restructured SOEs function in a manner that does not divorce them from the interests and well-being of the public, who are both the consumers of services and the “shareholders”.
Differences in method
An important distinction between the methods used by regulatory agencies and those used by competition authorities is that of the timing of the intervention.
Regulation is usually prospective and consists of legislation, regulations, rules, directives, and the terms and conditions of licences, all of which are aimed at preventing harmful business practices. These rules are determined in advance and will pertain to situations that may arise in the future. By contrast, competition law, with the exception of merger control, is applied retrospectively by the competition authorities only once a concern in this respect is raised or identified.
The law is applied as the need arises in each individual case.
The emphasis on technical expertise in sector-specific regulatory agencies can lead to an underestimation of economic or competition principles, and of the need to meet Government’s broader socio-economic, developmental and environmental objectives. Regulatory interventions can have the undesirable effect of limiting innovation and investment or even of reducing competition by creating distortions in the marketplace. “Captive regulation”, in which regulators are under obligation to industry groups, norms and practices, is also a common problem. Conflict between the optimal technical solution and the optimal competitive solution to a certain problem is therefore a distinct possibility. The prospective characteristic of sector-specific regulation is further challenged by technological innovation, which is difficult, if not impossible, to predict.(2)
Notwithstanding the above, it is important to note that despite the potential contradictions in the objectives and methods of the different regulators, there should be no difference between the broad objectives of the respective authorities, which will invariably include affordable prices, quality improvements and choice for the consumer. (More specific issues such as universal access form part of the overarching policy framework and should normally be taken into consideration by both regulatory and competition authorities.) Moreover, regulation is often seen as a means to mimic competitive conditions in the market, and is therefore likely to be established in markets with competition concerns. Hence, it is possible to find examples of close co-operation between institutions or of concurrent jurisdiction.
International experience
The interaction of competition authorities and regulators in promoting competition varies from country to country, and sometimes even within a particular country.
Four approaches can be adopted:(3)
The Australian Competition and Consumer Commission was recently mandated with some technical regulatory functions (option 1), such as regulating access to telecommunications networks, but this was an exceptional case. This approach was adopted to accommodate factors considered unique to Australia, such as the failure of courts to adjudicate effectively on issues regarding access and other complex regulatory matters.(4)
In international practice, there are few examples of either option 1 (competition authorities as regulator) or option 3 (concurrent jurisdiction), suggesting a demarcation of authority that places full jurisdiction regarding competition issues either with the competition authorities or with the sector regulator. Most OECD countries follow the mandate-driven division of labour approach (option 2).
Concurrent jurisdiction (option 3) appears to be rare. There are some examples of option 4 (jurisdiction with sector regulator), particularly in developed countries with established regulators and experience of antitrust. The United Kingdom has taken this approach and the United States has established this tradition in specific sectors (e.g. banking and telecommunications).
In practice, the demarcation of authority may vary within a country, and therefore the options mentioned above should not be taken as mutually exclusive. The ideal approach may vary across industries and will be determined by the characteristics of the industry involved, the current regulatory and adjudicative regime and the possibility of introducing or strengthening competitive forces. The suggested approach for the South African regulatory regime is therefore a sectorspecific approach that specifically addresses all of these issues.
Distinctions between industries
Before any conclusions concerning the interaction between regulatory authorities and the Competition Commission can be made, it is imperative to make a few distinctions.
First, one should separate network industries (e.g. electricity, water, gas and telecommunications) from other regulated industries (such as the sugar industry, agriculture, liquor). Network industries as defined earlier may, by virtue of their functionality and social impact, require regulation under all circumstances to ensure universal access and affordability of essential services. However, as noted above, the scope of network industries is being reduced through the application of new technologies.
Second, a distinction should be made between industries according to their envisaged trajectory or phase of development. In other words, is it a “transition” industry aiming at competitive conditions, or is it an industry that is judged to be most efficiently operated by a single provider with strict regulation (either partially or in its entirety)? Both trajectories are plausible, although the notion of “natural monopolies” is being progressively eroded, thereby diminishing the case for publicly owned regulated monopolies – more likely, the network part of the supply chain will require regulation. Transition industries require more careful scrutiny by competition authorities than industries in which competitive forces are unlikely and stringent regulation is opted for.
Third, one should distinguish between the industries in terms of their history of regulation, as well as their social significance. If the industry in question provides a public good, or a good or service that is deemed essential to the public interest, this is likely to affect the assessment of the agency that is most suited to enforcing competition in the industry.
Prospective sector-specific regulation dealing with competition concerns is becoming increasingly problematic in the global economy. Regulators cannot predict accurately how technology will change or which innovation consumers will favour. Overzealous regulation, or simply an inability to keep track of the rapid technological changes, may lead to undesired outcomes. This argument is often cited when explaining a global trend in changes in the balance of power between regulators and competition authorities.
There is a shift away from prospective sector-specific regulation to generally applicable competition law. This trend is seen to have additional benefits in terms of the consistency with which the application of competition principles are applied across industries. Regulation may be inflexible when confronted with a dynamic market. Globalisation and the liberalisation of the telecommunications market, for example, pose specific challenges to regulators as technological innovations spread rapidly across country borders, continuously changing the relevant geographical and product markets (via greater substitutability). Thus, except for those industries in which competition is unlikely or deemed socially undesirable and regulated monopolies are preferred, generally applicable competition law is preferable to sector-specific competition regulation.
As a rule, competition authorities should limit themselves to competition issues within the given framework (i.e. the strategy developed for the sector and social objectives imposed by policy-makers) and should not become involved in regulatory decisions outside their core competency. For instance, it would be impracticable for competition authorities to develop the expertise required to make decisions on “efficient use of frequency spectra” in the telecommunications industry. Therefore, coexistence of competition authorities and regulatory bodies is inevitable.
If the industry in question is a network industry in which competitive forces will be introduced, the technical decisions regarding licences, connectivity and rules should be made in consultation with the competition authorities. The competition authorities should consider other matters, such as mergers and acquisitions, with advice from the regulator on technical matters. For this decision-making process to have any success, an unambiguous demarcation of duties and a set mandate for co-operation should be embedded in the legislation governing the bodies in question. The demarcation of authority should be clear and procedures should be established for those cases in which the two bodies hold opposing views.
On the other hand, if the industry is a network industry in which no competition is foreseen, concurrent jurisdiction by the competition authority would be illogical. In this case, the regulator should deal with all matters relating to the industry. The competition authorities should review the options for the introduction of competitive forces into that industry and reassess the situation as technological advances are made. The advocacy function of the competition authorities is its sole means of operation in such a case.
In many industries it is foreseen that the level of regulation will be progressively reduced as the market becomes more competitive. Dispensing with a sector specific regulator during the transition or even afterwards is not necessarily the most sensible approach. The judicial system alone may not be able to cope with technical and commercial complexities of sector-specific issues. Moreover, even when competition has been introduced, regulation of entry and exit, prices, quality and accessibility is often deemed essential. In short, distinct industries require distinct approaches.
Pricing for maximal social welfare
As argued above, while Government recognises that the restructuring of SOEs through market incentives should lead to improved business and macroeconomic performance, the broader social, political, environmental and economic objectives summarised in the phrase “social welfare” still need to be addressed if Government’s overall objectives are to be realised. These concerns force public policy to reconsider the rationale for regulation.
Historically, implicit contracts between SOEs and society (or at least the most powerful groups) were mediated through the state. With that role came many distortions, including interference by politicians, operational inefficiencies protected from market discipline by state power, and “soft budget constraints” arising from, for example, tax exclusions or implicit state guarantees that allowed SOEs to borrow capital at below-market rates. To deal with such welfare-reducing measures, SOEs have been restructured in many different ways, and the resultant welfare effects have been equally diverse.
For instance, in a rigorous study of the “welfare consequences of selling public enterprises”, the World Bank conducted an analysis of 12 firms from four countries, decomposing the welfare gains and losses from various divestiture processes.(5)
Stakeholders included the government, workers, foreign buyers, domestic buyers, competitors and consumers. The diversity of experiences was striking, and it was found that SOE shareholders, management and workers were generally better off in most cases of divestiture. Because competition was often absent, consumers had the most unsatisfactory experiences. Much of this analysis has been “first-cut”; relating to the stakeholders most directly affected. Next-generation analysis of the welfare effects of privatisation will increasingly incorporate the public good issues described above. The study concludes: “Competition cannot do it all. It will remain necessary to regulate the prices of some large divested enterprises for two quite different purposes: to set prices low enough to preclude exploitation of consumers yet high enough to allow a fair return on capital; and to motivate producers to keep costs as low as possible.”
This problem of price -setting to achieve social welfare benefits has been studied in great depth in industries (e.g. electricity provision) in advanced, relatively competitive economies, and the market has been found wanting. (6)
Pricing is, therefore, emerging as a key dilemma for welfare maximisation in SOE divestiture.
This occurs not only where natural monopolies have simply been transferred from state control to the private sector, but also in the failure of competitive market theory in cases of undifferentiated commodities based on large fixed-capital overhead investments. In such cases, bargaining power is extremely diverse between customers. Bulk customers usually can and do demand discounts, either because they can purchase and store goods at off-peak hours and in large quantities, or because they have sufficient economic and political power to insist on price breaks.
Lower-income, less powerful customers are usually disadvantaged in such an unregulated market.
It is worth highlighting that the American electricity sector has demonstrated, that once divested and even broken into smaller competing units, power utilities often become oligopolies, engaging in collusive or outright anti-competitive practices to achieve fuller use of the large capacity that typically resides in these industries. The literature ranging across a variety of SOE divestiture and deregulatory processes suggests that the welfare effects of deregulating prices are often extremely badly distributed, so that low-income consumers and small firms will typically be disadvantaged. (7)
As will be discussed below, SOE restructuring can be quite difficult when the state plays diverging roles (e.g. producer, regulator and consumer). Nevertheless, it should be obvious that the maximisation of social welfare entails incorporating many of these problems within Government’s overall responsibilities. Therefore, in establishing a framework for restructuring SOEs, Government will need to address these issues through a broader framework defining its social welfare responsibilities.(8)
The regulatory provisions that accompany such restructuring will need to be designed to incorporate these diverse responsibilities.(9)
Although the values and objectives of regulation will vary in each case, social welfare will be an equally important objective along with the price- and performance-orientated objectives.
Conclusion: recommendations on competition and regulation
In the light of the above discussion, there is clearly a need for a sector-specific regulatory regime within the broader framework of current competition policy based on the type of industry and the potential for competition. Nevertheless, general principles that reconcile the different emphases of competition and more general regulation should also be established. Given the prevalence of residual natural monopolies in SOE sectors and the size of SOEs in relation to potential local competitors, Government should assure all stakeholders that restructuring will lead not only to competition, but also to an appropriate degree of regulation.
While competition policy remains the responsibility of the Department of Trade and Industry, the Department of Public Enterprises seeks to play an advisory role in relation to policies associated with each of the relevant sectors in which SOEs will be active.
The policy recommendations by the Competition Commission and Department of Trade and Industry indicate that, in the interim, Section 3(1)(d) of the Competition Act should be removed and concurrent jurisdiction should prevail in all regulated industries. Mergers should be approved by both authorities – abuses of dominance require a sector-specific approach. Unless this is specifically mandated by the relevant legislation, abuses of dominance and other restrictive practices should be investigated by the competition authorities in conjunction with the regulator.
In the longer term, regulators could concede jurisdiction on competition matters to competition authorities and seek their advice and opinion on other regulatory decisions. This reform requires amendments to the legislation establishing the individual regulatory authorities. All mergers should be within the jurisdiction of the competition authorities, albeit with the understanding that the competition authorities will seek advice from the regulatory agencies and that the dual notification process remains in place.
Mergers that involve regulatory decisions, such as the transfer of a licence, will remain under concurrent jurisdiction. This does not give the regulators a mandate to adjudicate on competition matters; rather, it provides for the consideration of divergent factors. The Securities Regulations Panel, for instance, evaluates takeovers as these impact on the shareholders, and related issues. No overlaps occur when the Competition Commission and the Securities Regulations Panel evaluate a proposed transaction based on their individual mandate.
Restrictive practices and abuses of dominance will require a sector-specific approach, depending on the nature of the industry. The regulatory reform should take issues such as network industries and the history of regulation and public good or public interest concerns into account. Regulation and specific rules for matters not concerning the Competition Commission will be maintained:
In all cases, the competition authority should monitor regulatory decisions on technical issues by the regulator, but it is not its responsibility to replace the sector-specific regulator. Inconsistencies between national and industry-specific competition rules should be addressed; industry rules should be amended to conform to the Competition Act of 1998. Co-operation between the agencies should be institutionalised and embedded in the respective procedures.
All should benefit from improvement in the regulatory environment in the key sectors (such as energy, telecommunications and transport) that are dominated by SOEs. South Africa’s globalising economy will benefit from lower prices and/or improved service outputs, which will enable it to become more competitive, thus creating more employment and investment opportunities. The unemployed and poor, in particular, will benefit from increased job opportunities and more affordable and available services. More certainty in the sectors involving SOEs will stimulate investment and enhance customer satisfaction, thereby ensuring that the quality of life for all is improved.
Notes:
The discussion that follows is drawn primarily from the document Competition and regulation: who has jurisdiction prepared by the Policy and Research Division of the Competitions Commission (1/2/2000). Mr Anton Eberhard of the National Energy Regulator also provided input.
Refer to Section 3.1 for a discussion on the merits of sector-specific regulation vs generally applicable antitrust.
OECD. 1999. Relationship between regulators and competition authorities, background note to Competition Policy Roundtable. OECD. 1999. Roundtable discussion on relationship between regulation and competition authorities: submissions by Australia, Korea, Mexico, United Kingdom, and the United States.
OECD. 1999. Aide-Memoire of the discussion. Secretariat report on Competition Policy Roundtable.
Galal, A., Jones, L., Tandon , P. and & Vogelsang, I. 1994. Welfare consequences of selling public enterprises: an empirical analysis. Washington, DC: World Bank.
Coyle, E. 2000. Price discrimination, electronic redlining, and price fixing in deregulated electric power. Report prepared for the American Public Power Association, January.
The definition of Government’s overall social policy objectives is considered to be beyond the scope of this policy paper. At best, it can highlight the areas where the restructuring of SOEs is likely to have an impact on social welfare, and within the scope of the restructuring brief,, address the immediate consequences. It will be the task of the regulator to establish the appropriate social welfare implications for pricing and services within such an overall framework.
Such a regulatory framework will also need to incorporate principles and safeguards including a distinct legal mandate for the regulator (free of ministerial control); professional criteria for the appointment of regulators; involvement of both executive and legislative branches in the appointment of regulators; fixed terms and protection from arbitrary removal; staggered terms of regulatory commission members, including appointment cycles that do not coincide with electoral cycles,; and a reliable source of funding. In addition to independence, regulators should have high standards of transparency, prohibitions on conflicts of interest, effective appeal procedures, external audits, public watchdog capacity,, and the power to terminate the services of possibilities for firing regulators in cases of misconduct or incompetence.