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«Organisation for Economic Co-operation and Development Organisation de Coopération et de Développement Économiques in co-operation with the ...»

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REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998

Organisation for Economic Co-operation and Development

Organisation de Coopération et de Développement Économiques

in co-operation with the Finnish Ministry of Trade and Industry

Twelfth Plenary Session of the OECD Advisory

Group on Privatisation (AGP)

Mr. Stuart HOLDER

National Economic Research Associates

(UK)

Privatisation and Competition: the Evidence from Utility and Infrastructure Privatisation in the UK Helsinki (Finland) 17-18 September 1998

REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998

PRIVATISATION AND COMPETITION: THE EVIDENCE FROM UTILITY AND

INFRASTRUCTURE PRIVATISATION IN THE UK

STUART HOLDER*

I. Executive summary This paper reviews the currently available evidence on the experience of the privatised utilities and infrastructure providers in the UK. It covers the telecommunications, gas, electricity and water industries, and also the provision of port and airport infrastructure.

It is difficult to identify a separate impact of privatisation, which was often accompanied by significant regulatory, competitive and structural changes. We do not know, moreover, how these industries would have performed had they remained in the public sector. Nevertheless, the evidence shows that the

privatised utilities and infrastructure providers:

increased labour productivity, and sometimes total factor productivity, at rates faster than those generally achieved before privatisation;

offered real price reductions (except in the water industry, where higher charges were needed to fund significant quality improvements). In the telecommunications and gas industries in particular, prices have fallen at a faster rate than they did before privatisation;

achieved sustained improvements in levels of service quality, especially in the telecommunications and water industries; and provided very substantial contributions to public sector finances.

A combination of privatisation, industry restructuring, regulation and liberalisation has allowed the companies to build upon the improvements achieved by better management of the nationalised industries in the early 1980s. It is hard to believe that these companies would have achieved these significant further improvements had they remained in the public sector.

* Stuart Holder, is Senior Consultant, at the National Economic Research Associates, 15 Stratford Place, London W1N 9AF, UK. Laura Altinger has provided valuable research assistance for preparation of this paper. The opinions expressed are those of the author and do not reflect the views of the National Economic Research Associates.

REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998 Competition has been introduced in the telecommunications, gas and electricity industries. To date, this process has generally been managed by the regulators, and has required some privatised firms to reorganise (either an accounting separation or the creation of separate subsidiaries) to ensure that competitors have non-discriminatory access to their networks. Longer-term issues still need to be addressed, particularly concerning the sustainability of universal service obligations in a competitive environment.

II. Introduction

The UK privatisation programme commenced in 1979, at a time when nationalised industries accounted for about a tenth of the country’s Gross Domestic Product and employed about 1.5 million people. Some of these industries were (or were thought to be) natural monopolies, often providing vital services such as water, electricity and gas to domestic and industrial customers. Others, including coal and steel producers, car manufacturers and ship builders, occupied what was sometimes characterised as “a position of strategic importance” to the UK economy.

Since then, more than 50 major companies (and dozens of smaller ones) have been transferred to the private sector, raising more than £60 billion for the UK government in the process. Many privatised firms face strong competition in an increasingly open world market. Others, notably the traditional utilities, became private sector monopolists, though most of these are now facing competition in some or all of their markets. Although some of its language may be different, the current Labour government is continuing to privatise (or, in some cases, establish “public private partnerships"), organisations such as London Underground and the national air traffic control service.

This paper reviews the currently available evidence on the experience of privatised utilities and infrastructure providers in the UK, including the telecommunications, gas, electricity and water industries, and also the provision of port and airport infrastructure. Academic research has focussed mainly on the impact of privatisation (and other changes) on firms' efficiency, as measured by labour productivity and total factor productivity. This research is summarised below, along with the findings from surveys carried out by NERA into the prices, service quality and financing of privatised industries in the UK.





It is difficult to reach conclusions from this evidence about the impact of privatisation. One reason for this is that privatisation has often coincided with other significant changes, for example to the regulatory structure, the nature of competition or even the basic structure of the relevant industry.

An equally difficult problem is that of establishing the correct counterfactual: what would have happened if these firms had remained in the public sector? As noted in Section IV, there is convincing evidence that the nationalised industries performed better in the 1980s than they did in the 1970s, including some industries for which privatisation was not on the political agenda during this time. If this improved performance would have been maintained (or bettered) in the absence of privatisation, then some of the apparent benefits from privatisation may be illusory.

The rest of this paper is structured as follows. Section III describes the way in which each industry was privatised, including the market structure and regulatory framework adopted on privatisation, and also identifies significant developments since privatisation. Section IV then considers the various ways privatisation might affect an industry’s performance and reviews the available evidence on the performance of UK utilities and infrastructure providers before and after privatisation. Section V draws some conclusions.

REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998 III. Overview of utility and infrastructure privatisation in the UK This section describes the process of industry restructuring, privatisation and regulation in UK utility and infrastructure industries, including both the privatisation process and any significant regulatory or competitive changes, which have occurred since privatisation. Sections III.1 to III.6 cover the individual industries in the order they were privatised, then Section III.7 draws together some common themes.

III.1. Ports

The first major utility or infrastructure privatisation was that of Associated British Ports (ABP), formerly the British Transport Docks Board, which was privatised in February 1983. ABP owns 22 large and small ports, accounting for about a quarter of total UK port capacity (by value of trade). There is strong competition between UK ports, and the industry has a historic tendency to provide excess capacity. UK ports also face competition from ports in Belgium, Holland, France and Germany. In view of this competition, ABP is largely unregulated, though it is subject to general competition law and there are also backstop procedures for appeals to the Secretary of State for Transport over the level of charges.

The main change to the industry since privatisation was the abolition of the Dock Labour Scheme in 1989, which removed a number of historical restrictions on port owners. This allowed ABP and other port owners to manage their workforces far more efficiently, and also to contract out some operational activities, such as cargo handling. This is one reason for ABP's apparent strong performance during the "recession period" shown in Table 3.1 below.

III.2. Telecommunications

Before 1981, all telecommunications services in the UK were provided by the Post Office. In 1981 a separate public corporation, British Telecom (BT), was created to carry out the Post Office's telecommunications functions, and BT was privatised in November 1984. A new regulatory body, the Office of Telecommunications (OFTEL), was created both to regulate BT's prices and service quality and, more importantly, to oversee the interconnection arrangements between competing operators.

Some of BT's prices are subject to a price cap formula determined by OFTEL. At first, this covered only exchange line rentals and local and national direct dialled calls, accounting for about 50% of BT group turnover. Subsequently, the scope of the price control was extended to include operator assisted calls, directory enquiries, some private circuits, international calls and connection charges, accounting for about 65% of BT group turnover. Last year, in view of the increasing extent of competition (see below), the price cap was amended so as to apply only to the lowest spending 80% of residential customers and a package to protect small businesses, and to exclude directory enquiries services.

At the time of privatisation, BT was a de facto monopoly supplier of basic telephone services. Even though a national competitor, Mercury Communications, had been licensed in 1982, it was unable to

REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998 supply basic telephony until it had an interconnection agreement with BT, which was eventually determined by OFTEL in October 1985. At the time of privatisation, moreover, the government announced its intention not to license any further fixed-link competitors until 1990 at the earliest.

Between 1985 and 1991, BT and Mercury enjoyed a duopoly in the market for fixed-link telephone services.

Following its review of the duopoly in 1990-1, the government decided to allow further (and, in theory, unrestricted) entry by suppliers of domestic fixed-link telephone services. Importantly, cable television operators were to be allowed to compete in their own right (rather than just providing infrastructure for BT or Mercury, as was previously the case). BT's market share has now dropped below 75% of call revenues (ranging from 52% for international calls to 85% for local calls), and 90% of exchange line rental revenues.

The framework for interconnection between operators has had a major impact on the nature of competition, particularly between BT and other operators. OFTEL's initial determination in 1985 was favourable to Mercury, since it ignored the impact of BT's "access deficit" (which meant that BT was forced to keep call charges high in order to compensate for low line rental charges). This arrangement was formalised in 1993, when access deficit charges were introduced for other operators, but a waiver was granted so that operators only paid access deficit charges when they had achieved a 10% share of international or inland calls.

The structural problems associated with introducing competition in the presence of a vertically integrated, dominant incumbent were addressed more directly by OFTEL's requirement that, from 1995, there should be an accounting separation between BT's retail business (i.e. supply of calls), network business and access (i.e. supply of lines) business. Under this new arrangement, BT's network division charges all operators (including both BT's retail division and its competitors) for the use of its network according to a common set of charges.

III.3. Gas

British Gas (BG) was privatised in December 1986 as a vertically integrated producer, transporter and supplier of natural gas. Although other suppliers had been able, in theory, to purchase and transmit gas for sale to final users through BG's pipelines since 1982, BG was still a monopoly supplier at the time of privatisation.

A new regulatory body, the Office of Gas Supply (OFGAS), was created to protect the interests of customers, but its powers were restricted to the "tariff" market for customers with an annual demand of

REGULATION, COMPETITION AND PRIVATISATION

Helsinki, 17 - 18 September 1998 25,000 therms or less. BG's monopoly over the "contract" market (for customers using more than 25,000 therms a year) was abolished, and regulations to allow common carriage through BG's pipelines were strengthened. Notwithstanding the absence of actual competitors, this market was thought to be sufficiently competitive that it should be subject only to general competition law (rather than industryspecific economic regulation).

Within a year of privatisation, BG was referred to the Monopolies and Mergers Commission (MMC), following complaints of discriminatory behaviour in the contract market. The MMC found that BG was practising extensive discrimination, and that this was acting against the public interest by imposing high prices, deterring entry, increasing the risks faced by customers and imposing additional costs on those users whom BG refused to supply with interruptible gas. BG was required to produce price schedules for all supplies to large customers, to publish details of the terms and conditions of common carriage, and also to contract for no more than 90% of the gas from any new field.

The Office of Fair Trading (OFT) reviewed the impact of these remedies in 1991, and found that they had been ineffective in terms of encouraging competition to BG. The OFT recommended that BG should release some of its contracted gas, that the upper threshold (25,000 therms a year) on the tariff market should be reduced, and that BG should divest (or at least create an arm's length subsidiary for) its gas transportation and storage business.



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