Infrastructure deregulation and privatization in industrialized and emerging economies.

Author:Trebing, Harry M.

For the past twenty-five years a diverse group of large users of energy and telecommunications, potential entrants, and market-oriented reformers have aggressively moved to change the organization and governance of public utilities in both industrialized and developing nations. The replacement of regulated private monopoly and state-owned enterprises through privatization and deregulation has been a source of continuing controversy. This paper will examine actual experience to get a better appreciation of evidence of market and public policy failure.

Deregulation and Privatization of Energy Utilities in Industrialized Nations

The traumatic collapse of the energy markets following the Enron scandal and the California price-rigging expose led to growing evidence of market failure in the United States. Trading markets revealed a vulnerability to manipulation, preferred treatment of affiliates by parent companies, and fraudulent reporting of pricing and sales information. (1) Academic research also showed that sellers could approach joint profit maximization through trading even in the absence of direct collusion, (2) and common gaming strategies among traders could lead to forbearance and cooperation. (3) Further, it has been argued that trading markets will not assure adequate transmission capacity since hedging assumed an elasticity of supply that was nonexistent and trading could easily be distorted by incentives to maintain profits through congestion and foreclosure of rivals. Similarly, there were growing doubts about the ability of generation capacity markets to ensure adequate reserve margins.

More important, after the collapse of 2000, the electric utility industry in the United States divided itself into two categories. The first consisted of strong asset-based utilities that were capable of capturing all of the network and coordination economies (4) previously held under regulation, while at the same time acquiring significantly greater market power through a selective program of mergers and acquisitions. (5) The second category of firms was those which had aggressively diversified into nonregulated activities, especially trading, and significantly expanded into markets outside of their service territory. By 2003, these firms were in desperate financial straits, most facing financial reorganization or bankruptcy. Similarly, the rapid growth and decline of independent merchant generators cast serious doubt on the sustainability of a competitive wholesale electricity market and the credibility of market-based rates. By 2004, independent generators had been significantly displaced by acquisition programs of the asset-based utilities, their unregulated affiliates, or by private equity players (to be discussed later).

Critics now charged that deregulation did not lower prices for industrial or for residential customers, (6) improve service, or resolve major environmental problems. (7) Of particular interest, the highly conservative free-market CATO Institute viewed electricity deregulation as a failure and recommended as a second best solution the re-introduction of traditional regulation. (8)

In the United Kingdom, Steve Thomas reviewed the British model for creating competition and found significant deficiencies in competitive generation, the concentration of generation and retail functions, the claims of alleged superiority of private over public ownership, and the development of a credible wholesale market that would not burden retail markets. (9) Catherine Price concluded, "Since it is doubtful even whether consumers have benefited from competition (in the UK), it is very difficult to argue that overall welfare has increased." (10)

Deregulation and Privatization in Telecommunications in Industrialized Nations

Following the WorldCom scandal and the collapse of the telecom market, two major factors dealt a devastating blow to the prospects for intra-industry competition in telecommunications in the United States. First, permissive merger policies have permitted the Regional Bell Holding Companies (RBHCs) to move to dominance in the wireline market. The original seven RBHCs have merged into four, and the largest, Verizon and SBC, established clear positions of dominance through vertical integration in their respective acquisitions of MCI and AT&T, their diversification into wireless communications through their Verizon and Cingular affiliates (which now account for 67 percent of all U.S. wireless customers), and their aggressive move into broadband service, television, and VOIP. These programs have established the largest RBHCs as the new centers of power in the telecommunications industry. Their goal is dearly to achieve an optimal corporate structure which combines basic service and new growth markets to capture all inherent network and coordination economies so that they can supply each relevant market at a cost lower than potential entrants or rivals. In this fashion, Verizon and SBC (now renamed AT&T, Inc.) are able to participate in new technology and balance the gains and risks in growth markets with the stabilized earnings in traditional wireline services.

A second factor strengthening the position of the RBHCs was the decision of the U.S. Court of Appeals for the District of Columbia on March 2, 2004, which stated that the FCC's earlier policy of compelling RBHCs to offer access to their plant and facilities to potential competitors at prices based on total element long run incremental costs contained serious flaws. (11) In its modified Triennial Review Remand Order the FCC essentially abandoned its effort to promote direct competition...

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