Understanding Regulation

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Understanding Regulation
Research Review Seminar - I

• Jogendra Behera
• Dec 12, 2007

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What is a Market

• "A market is a social arrangement that allows
  buyers and sellers to discover information and
  carry out a voluntary exchange of goods or
  services. http//en.wikipedia.org/wiki/Market
• An arrangement wherein buyers and sellers can
  exchange resources, goods, and services. A market
  may be a physical place such as a store or an
  auction gallery, or it may occur through other
  arrangements such as a telephone and Internet
  transactions a market is said to exist whenever
  or wherever a buyer and seller enter into an
  exchange. http//mdk12.org/assessments/vsc/social
  _studies/bygrade/glossary.shtml

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Competition

• Is a situation in a market in which firms or
  sellers independently strive for the buyers
  patronage in order to achieve a particular
  business objective for example, profits, sales or
  market share (World Bank, 1999)
• A market in which rival sellers are trying to
  gain extra business at one another's expense and
  thus are forced both to be as efficient as
  possible and to hold their prices down as much as
  possible. Competition is thus a sophisticated yet
  uncoordinated mechanism that sorts out the
  actions of millions of buyers and sellers and
  uses the resulting pattern of supply and demand
  to determine what shall be produced, in what
  quantities, and at what price.
• http//www.mvp.cfee.org/en/glossary.html

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Competition

• Adam Smith stated in 1776, while he intends
  only his own gainhe is led by an invisible hand
  to promote an end which was no part of his
  intention that is to maximize the wealth of
  the nation
• The competitive market guides and controls the
  self seeking activities of each individual to
  maximize the wealth of the nation.
• Our mission is to deliver a competitive
  framework for the growth of successful businesses
  and a fair deal for consumers. We want to help
  consumers and businesses enjoy more choice,
  better service, safer products and competitive
  prices.
• Adam Smith, The Wealth of Nations (1776),
• (References from other sources)

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Competition

• The competition in the market will
• Promote efficiency ensure best possible
  utilization of resources (productive and
  allocative efficiency)
• Encourage Innovation
• Ensure abundant availability of goods and
  services of acceptable quality at affordable
  price
• Offer wide choice to consumers
• Inference from general readings Kahn, CRC
  articles, Wikipedia, Internet articles etc.)

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Different views of Competition

• Behavioral Approach
• It emerged during the classical period of
  economics
• Competition was considered to be a process of
  rivalry between participants in the market
• The participants would compete by changing prices
  in response to market conditions, thereby
  eliminating excessive profits and unsatisfied
  demand.
• Structural Approach
• The neo-classical approach generated the view
  that a market could be defined as competitive
  when there was a significantly large number of
  sellers of homogenous products
• so that no sellers had enough of a market share
  to enable them to influence the product price by
  changing the quantity that they put into the
  market.

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Different views of Competition

• Structural Approach
• The structural approach has survived as the
  standard model for analysis profound influence
  on policy making
• Emphasis on market structure ? structure,
  conduct, performance approach (SCP approach)
  towards the competition policy
• (Competition, regulation and regulatory
  governance an overview Cook, Kirkpatrick,
  Minogue, Parker, 2004
• SCP, NIEO and Beyond Cassey Lee, 2007)

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Economic Policy/Reforms

• There is a long history of competition and
  regulation in developed country
• Canada enacted its first Competition Law in 1889.
• In the 1890s, many of the states of USA enacted
  Competition Laws. The Federal Government of USA
  enacted the (Sherman Anti-trust Act 1890),
  Clayton Act (1914) and Fair Trade Commission Act
  (1914).
• In the 1980s, under the Government of Margaret
  Thatcher, most state-owned enterprises in the
  industrial and service sectors, which since the
  1940s had been nationalised, were privatised.
• Cycle of regulation and deregulation
• In U.S market with limited regulation prior to
  1930 Industry wide regulation after Great
  Depression 1930 - 1970 Deregulation after 1970
  after the onset of Stagflation

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Economic Policy/Reforms

• In the past most developing countries were
  characterized by significant government
  involvement in their economies marked by
  dominance of large state owned enterprises.
• Economic reforms were undertaken such as trade
  liberalization, opening up of economy, promoting
  FDI, and facilitating private sector
  participation.
• The poor performance of State Owned Enterprises
  and consequent pressure on budgets forced
  governments to reduce support to SOEs and move
  towards privatizing them or restructuring them.

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Shift in Public Policy

• The thrust of economic reforms has been to allow
  for more competition.
• The underlying rationale is that competitive
  markets ensure efficiency resulting in best
  choice of quality, lowest prices and adequate
  supplies to consumers
• (References General Readings Competition and
  Regulation reports of CUTS)

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Shift in Public Policy

• The shift in the public policy over the last
  two decades away from state ownership and state
  responsibility for the provision of services, to
  private ownership and private provision with
  enhanced state regulation is sometimes described
  as the rise of regulatory state (Majone, 1997)
• Alternatively it has been referred to in terms of
  the invisible hand of the market being
  supplemented by the visible hand of the
  regulators (Jackson and Price, 1994) In this
  regime the state ceases to be directly concerned
  with the provision of goods and services and
  instead concentrates on regulating private
  markets to promote economic and social welfare.
• (References from other sources Competition,
  regulation and regulatory governance an overview
  Cook, Kirkpatrick, Minogue, Parker, 2004 )

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Market Failures

• Significant Externalities
• Nature of Goods Public goods, merit or demerit
  goods
• Information asymmetry
• Incomplete market
• Monopoly
• Inequality
• (Economic Regulation A Preliminary literature
  review and summary of research questions
  Parker)

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Regulation

• The possibility of market failure underpin the
  economic rationale for state regulation of market
  economies.
• Regulations can take different forms with
  different roles
• Health, safety regulations and environmental
  regulations can be rationalized on the basis of
  imperfect information and externalities
• Economic regulation of public utilities can be
  explained by economies of scale and scope and
  need to protect the consumers from monopoly
  exploitation
• Aspects of fiscal policy can be rationalized on
  the basis in terms of wealth and income
  redistribution
• Regulatory intervention for universal service
  obligations etc.

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Regulation

• Regulation cannot be limited to economic issues
  means to ultimately achieve non-economic ends
• Intentions and outcomes are therefore defined by
  a combination of economic, social, political and
  bureaucratic factors and cannot be attributed to
  one set of factors alone
• Involvement of disciplines other than economics
  (law, political science, sociology etc.)
• Broad definition the use of public authority
  to set and apply rules and standards (Hood et
  al, 1999)
• (Economic Regulation A Preliminary literature
  review and summary of research questions
  Parker)
• As an effort by the state to address social
  risk, market failure or equity concerns through
  rule based direction of individual and society
  (Planning Commission consultation paper on
  Regulation)

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Regulation

• Regulation is a complex balancing act between
  advancing the interests of consumers, competitors
  and investors, while promoting a wider, public
  interest agenda.
• minimum prices to benefit the consumer (maximize
  consumer surplus)
• ensure adequate profits are earned to finance the
  proper investment needs of the industry (earn at
  least a normal rate of return on capital
  employed)
• provide an environment conducive for new firms to
  enter the industry and expand competition (police
  anti-competitive behavior by the dominant
  supplier)
• preserve or improve the quality of service
  (ensure higher profitability is not achieved by
  cutting services to reduce costs)
• identify those parts of the business which are
  naturally monopolistic (statutory monopolies that
  are not necessarily justified in terms of either
  economies of scale or scope)
• take into consideration social and environmental
  issues (e.g. when removing cross subsidization of
  services).
• (Minogue, 2000)

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Brief History

• Origin in progressive era of U.S economy
• Early scholarly contributions that evaluated the
  new regulatory institutions and political economy
  of the American regulatory state (Cushman 1941
  Bernstein 1955 Mitnick 1980).
• Next chapter in regulatory studies opened in the
  1960s and 1970s, when the USA and other developed
  nations experienced a burst of new forms of
  consumer, civil rights, health and safety, and
  environmental regulation, and with these changes
  came renewed interest in regulation (Wilson 1980
  Bardach Kagan 1982).
• More recently, there has been a move away from
  treating the USA as the main arena for regulatory
  studies, especially as the European Union has
  become an important trendsetter in both risk
  regulation and regulation for competition (Majone
  1994, 1997 Moran 2003 Vogel 2003).
• An important strand of regulatory studies emerged
  out of corporate crime research. Especially after
  the Watergate scandal in the early 1970s, this
  field has attracted many of the brightest and
  best postwar criminologists. Later on these
  experts got interested in regulation. Many
  criminologists studying regulation, in turn,
  became engaged in sociology.

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Brief History

• Initially the regulation study was based upon Law
  and Sociology and later on the importance was
  given to Law and economics
• Regulation had long been an important topic in
  mainstream economics. Nobel Prizes were won for
  work on regulation, including a cluster awarded
  to economists from the University of Chicago who
  were critics of certain kinds of regulation.
• The spread of privatization around the world has
  created the renewed interest in regulation

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Natural Monopoly Economic Regulation

• Natural Monopoly
• Multiple firms providing a good or service is
  less efficient (more costly to a nation or
  economy) than would be the case if a single firm
  provided a good or service.
• industries where fixed costs predominate,
  creating economies of scale which are large in
  relation to the size of the market
• Examples Electricity, telecommunications,
  Railways, Water Services etc.

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Natural Monopoly Economic Regulation

• In case of other sectors (other than natural
  monopolies) Regulation operate essentially at
  the periphery of the markets affected.
• The role of regulation is generally conceived as
  one of the maintaining the institution within
  whose framework the free market can continue to
  function, of enforcing, supplementing and
  removing the imperfections of competition

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Natural Monopoly Economic Regulation

• In the case of Natural Monopoly the essence of
  regulation is the explicit replacement of
  competition with governmental orders with
  principal institutional device for assuring good
  performance.
• In the case of natural monopoly the primary
  guarantor of acceptable performance is conceived
  to be not competition or self restraint but
  direct governmental prescription of major aspects
  of their structure and economic
• There are four principal components of this
  regulation that in combination distinguish the
  public utility from other sectors of the economy
  control of entry, price fixing, prescription of
  quality and conditions of service, and an
  imposition of an obligation to serve all
  applicants under reasonable conditions.
• (The principles of economic regulation, A.E.Kahn)

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Traditional way of regulating public utilities

• Firms can be regulated in terms of their profits
  or prices, as well as their quality of service.
  The three general forms of regulatory instruments
  are
• Cost of Service Regulations
• Regulator agreeing the level of operating costs
  and the capital costs
• Added a profit or agreed rate of return based
  upon firms cost of capital on the asset base
• This method is associated with cost padding up
  and over investment (Averch and Jhonson, 1962,
  A-J-W effect)

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Traditional way of regulating public utilities

• Price Cap Regulations
• Profits are not determined by regulator but are a
  residual
• Regulator agrees the forecast operating and
  capital costs and applies a efficiency gain
  factor X benchmarked with other firms
• Price cap CPI /- X Incentive to the firm to
  outperform in terms of reducing costs or
  attracting customers, leading to higher profit
• Sliding Scale Regulations
• Combination of the price cap and cost of service
  regime
• Price cap operate upto a given level of reported
  profit
• Beyond that, the prices are reduced to consumers
  thus sharing the efficiency gains with consumers
• (Competition, regulation and regulatory
  governance Cook et al.)

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Competition Policy Sectoral Regulation

• Competition policy is essentially understood to
  refer to those governmental measures that
  directly affect the behavior of firms and the
  structure of the industry -- those government
  measures that directly affect behavior of
  enterprises and structure of industry. (Khemani
  and Mark Dutz 1996)
• Economic policies adopted by Government, that
  enhance competition in local and national markets
  (such as, policy of economic de-regulation and
  privatization etc.) and
• Competition law designed to stop anti-competitive
  business practices by

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Competition Policy Sectoral Regulation

• Competition Authority A separate agency to
  implement the competition law (Competition
  Commission of India in the case of India)
• Sectoral Regulations This is in addition to the
  Competition authority in the sectors where
  there is a natural monopoly
• In market regulator vis- a vis off market
  regulator

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Competition Policy Sectoral Regulation

• Competition Authority
• Off market regulator
• Prevents market failure through law enforcement
• Three basic elements of a modern competition law
  anti-competitive agreements, abuse of dominant
  position and combinations
• Applies competition law across all sectors

• Sectoral Regulation
• In market regulator
• Sets rule of the game entry condition,
  technical details, tariff, safety standards,
  access etc.
• Direct control price/quantity/quality

Issue of overlapping and conflict between
Competition Authority Sectoral Regulators
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Regulation in Developing Countries

• Lack of regulatory commitment political
  expediency and the limits of independence
• Political expediency can undermine regulatory
  independence
• Lack of transparency, participation, and
  accountability
• Institutional fragility
• Challenge in developing new public institutions
  in developing countries
• Regulatory substance compromised lack of
  capacity and competency
• Quality, credibility and impact of regulatory
  decisions
• Lack of specialized skills in utility regulation
• Regulatory contracts also under stress
• Obsolescence of long term contracts is frequent
• (Infrastructure Regulation in Developing
  Countries Anton Eberhard, PPIAF)

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Efficiency and Effectiveness of Regulation

• Regulatory Costs
• Direct Costs
• Budget of regulatory departments
• Indirect Cost/Compliance Cost
• Imposed on remainder of the economy in terms of
  complying with the regulations
• Usually hidden from the view Efficiency of
  Regulation Administrative and compliance cots
  of regulation should be compared to the benefit
  accruing from the regulation
• Regulatory Impact Assessment (RIA)
  Systematically assessing the benefits and costs
  of a new or existing regulation
• (Kirkpatrick Parker, 2002)

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Efficiency and Effectiveness of Regulation

• Five principles to determine the relevance and
  effectiveness of regulations (Haskins, 2000)

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Different levels of regulation

• Schema for assessing different regulatory and
  governance structures (Parker, 1999)

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Some examples Role of Regulators
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Thank You