Economics of infrastructures 7

Market design
Regulatory challenges
In the

market design the regulator must safeguard that the systems:

Has no underinvestment
Receives sufficient maintenance
Is constructed using appropriate maintenance
Has reasonable pricing

The question is the, how to design such a credible regulatory regime (market design) that
allows for these aspects. Especially taken note of the complex arena in which the decisions
have to be made, taking note of the social technical aspect, Government, Industry,
Consumer and if applicable the Regulatory Agencies.
The systems characteristics of infrastructure make this design even harder due to market
and governmental failures
Market
Market Power
External effects and public goods
Lack of information
Specific goods
Transaction cost

Government
Information asymmetry
Principle agent problem
Policy conflicts
Captive state

Even though that infrastructural systems have comparable characteristics, there are multiple
ways in which these can be regulated. Comparable characteristics does not mean that they
can be regulated in the same way, each specific type of market needs its own regulation to
ensure high economic efficiency.
So how to design a market in which we can set regulatory boundaries for infrastructural
markets taking into consideration all these aspects (safeguarding, socio-technical and
characteristics of market and governmental failures). It is about connecting the institutions
with the various types of technologies (electric, water, gas) in which each type of technology
needs a certain approach. This approach is determined based on the coherence between the
technical co-ordination and the institutional co-ordination.

The technical co-ordination: ensuring that

the technology (system) is able to perform
its designed function.
Interoperability
(system
complementarity)
Capacity management
Strategic, tactical and operational
management
System management (safeguarding
quality)
The institutional co-ordination: What kind
of rules determine how the system can be
controlled (which is determined by the
technology of the system).
The degree of coherence: are the correct rules in place to ensure that the technical system
is operated in the correct way?
The level of coherence in the end determines the infrastructural performance of the system
(cost, capacity, environmental issues, operation, maintenance, lifecycle).
This framework approach must be applied to all different system in which it will ensure that
the correct institutional co-ordination is matched with the requirements from the
technological system (infrastructure). Still the question remains, what type of coherence do
we require?
From this point of view there are three possible approaches of co-ordination:

Centralized: few decision makers that decide on how the system should behave and perform
(regulated), so driven top-down.
Decentralized: units and parts of the system are controlled locally. These local parts ensure
that the total system functions.
Peer to peer: Partners are controlling each other and are deciding together how the system
should be controlled.

Markets and co-ordination

The World Bank developed a scheme on how to select which regulatory system per sector.
This scheme uses the following aspects:
Outcome: the performance of the system, its influence on society, cost welfare etc. The
outcome that we can evaluate against our standards and preferences and if a change should
be made.
Additional regulations: Equal for everyone in society, safety, labor rules, environmental
issues (boundaries)

Observations:
External organization: Technology, coverage, the nature of the system, activities in the
system
Choices!
Competition modality: choices we can make on how the system should operate and what
type of competition we desire
Ownership: how is the system being owned, private, public etc.
Tariffs and conditions: how should we regulate the tariffs and conditions of the system?

Is regulation possible
In order to regulate, one needs a regulator that knows enough about to system and sector to
regulate properly. This implies that we need a stable technology, demand and products (to
ensure that the regulator can understand the market and act accordingly).
Even if there is only one firm to regulate, this does not mean we cannot regulate. Mostly
neighboring countries have the same types of infrastructure in which can become
competitors. These are a potential threat to the incumbent, as he knows that when he does
not perform well he might lose his market share. A government can decide in that case not
to regulate, but this all depends on the number of players in the market and how easy and
quick such a new entrant can enter the market. If the entry takes too long, the incumbent
has enough time to act strategically and block or deter entry.
Last the durability of the regulation is important, if we regulate can we then ensure that the
advantages for the consumers maintain, or will the firm react strategically? This depends on
how dynamic the sector is and how fast the firm, but also the consumer are able to respond
to market change.

How to create competition in the market

Competition modalities in network sectors
Competition in markets
Competition between systems
Competition between users on a systems
Competition for a market concession
Completion yardstick
No competition

Competition in markets (car rentals)

Several suppliers
Many consumers
Free entry
Control and specification is possible
Only requires competition law and standards for interconnection

Competition between systems (mail or e-mail)

To what extent is there substitution between the system

Are the systems providing substitution at the same time?
Are the providers providing the public good in the same regional area?
o Lead to cross subsidization (cities vs rural areas

Competition between users on a system (internet providers)

Can the system be unbundled into separate networks

When there are multiple suppliers on the same network with multiple end users
When the access to the network is regulated by means of tariffs and conditions
When the use of the network can be coordinated
Competition for the grids lead benchmarking with peers

Competition for a market concession (postal service, water supply)

Private and foreign ownership allowed (both are required since sufficient bidders are
required for competition, only two lead to collusion)

No real public interest involved (or else this could not be provided by private
suppliers, else a government should take control).
The assets must be transferable (change in contract and ownership due to tendering)
Real competition in tendering for the concession
Competition between suppliers leads to benchmarking with peers

Yardstick competition (health and education)

Are
Are
Are
Are

the prices of competitors observable

there sufficient peers to provide the same utility
the outputs measurable
the circumstances of these providers comparable so that comparison is possible

No regulation (transmission networks)

Tariff regulation by means of price caps

Quality observable -> price cap
Quality not observable -> rate of return

Ownership

Private (domestic or foreign) shareholders

Public: State, province, municipality
Public shareholdership or direct management
Collective ownership; foundation, etc.

Argumentation for private ownership

+ shareholders pressure companies have to respond to the shareholders to improve
+ takeover much pressure means that the board can be replaced or be taken over
by a different firm
+ capital providers allows for attracting private capital providers
- can lead to crowding out due to the main driver of the profit driven approach
instead of the public provision approach
- staffing problems in the public situation the loans are lower than in a private
situations, it might be more difficult to find people

Tariff regulation

Perfect competition
o No regulation required, just anti collusion policy
o Transparency in the market
Imperfect competition
o No regulation required, just anti collusion policy
o Transparency in the market
o Entry restrictions
Natural monopoly
Competing interconnection and capacity use
o Regulation of providers and operators
o Cross subsidies of services (special structure)
o Taking not of network externalities and market power
The fringe
o Contestable competition, we expect that potential competition is making sure
that the operator of the system is behaving efficiently.