different sectors justified?
Abstract
The aim of this paper is to assess whether the tendency of different regulatory priorities in the EU - namely increasingly stricter separation of the networks in the electricity sector and predominantly simple access regulation in telecommunications99 - is justified, considering that in theory stricter separation should lead to better access but, arguably, during this policy, competition developed better in the telecommunications than in the electricity sector. The UK is compared to Germany, in order to be able to carry out cross country (as well as cross-sectorial) analysis. The attitude towards vertical separation between these countries is very different: the UK typically choses stronger while Germany weaker solutions, which make them an interesting basis of comparison.
The chapter has two parts. The first part looks at the theory behind vertical separation while the second looks at the issue in practice. The theoretical part starts with describing the pros and cons of vertical separation, focusing on efficiency. The second section of the first part focuses on competition and vertical separation (between monopolistic and competitive levels). The third part looks at the different degrees of vertical separation. The first part concludes that vertical separation could result in efficiency gains or losses, but it should facilitate competition because it makes entry easier. The different degrees of separation may be used to strike a balance between the two: enabling higher efficiency (when
99 John Vickers, ‘Competition and Regulation in Vertically Related Markets’ (1995) 62 (1) The Review of Economic Studies, 1, 2
90 integration leads to enhanced efficiency) while providing adequate entry and thereby facilitating competition.
The second part tests whether vertical separation does facilitate entry in practice.
First the relevant EU regulations are described. Then the basis of the comparison, the regulatory solutions chosen by the UK and Germany (within the EU framework) are presented. The different degrees of vertical separation having been used in these countries are then contrasted to data on entry from the previous chapter.
The assessment finds that in electricity stricter regulation is followed by the incumbents’ market share loss, but there is no evidence for this in telecommunication, which justifies the different policies for the sectors.
Introduction
It is well-understood that vertical integration can hinder competition when market power exists on one of the production levels concerned. This is because, when there is a dominant firm on one of the levels in the supply chain, this firm can leverage (or maintain) its market power to the competitive level through vertical integration by discriminating against competitors on the competitive level.100 Electricity and telecommunications are both network industries. This means that in their supply chain there is a network that is essential to provide services for the consumers. Arguably, it is not economically viable to duplicate these networks, which means that they constitute a natural monopoly.101 From the argument
100 This is why such vertical mergers are normally blocked by competition authorities.
101 The natural monopolistic nature of the networks - especially the telecommunications network – is debatable. The cable network can compete with the fixed telephone network and also mobile networks compete with each other and to some extent with the fixed networks.
91 above it follows that in order to facilitate competition integration between the network and the other (potentially competitive) levels of the supply chain should be prevented. As a matter of fact the key idea behind the sector reforms, creating competition, was meant to be achieved by localizing the monopolistic element and keeping it contained.102 Thereby, competition can emerge on the rest of the levels.
The regulatory solutions put in place to contain the monopolistic element are, therefore, of crucial importance from the perspective achieving the aim of the reforms: creating competition in the electricity and telecommunications sectors.
One of the main differences between the electricity and telecommunications reforms is in these regulatory arrangements, which are responsible for the restriction of monopoly: in the electricity sector the monopolistic levels have been strictly separated while in the telecommunications regulation only access regulation has been initiated to tackle leveraging of market power by discriminating against competitors on the access terms.103
Although in the electricity sector the regulatory solutions put in place to contain the monopoly are generally stronger than the ones used in the telecommunications sectors, there is no clear indication for competition to be stronger in the electricity sector than in the telecommunications sector. Paradoxically, there seem to be more evidence suggesting the opposite: more competition in the telecommunications sectors than in the electricity sectors.
This chapter aims to answer whether the different regulatory vision in respect of vertical separation in the electricity and telecommunications sector is justified in practice. In answering the question, first the pros and cons of vertical integration
102 Or quarantined CF Paul L. Joskow, Roger G. Noll, ‘The Bell Doctrine: Applications in
Telecommunications, Electricity, and Other Network Industries’ (1999) 51 (5) Stanford Law Review, 1249, 1250
103 Damien Geradin, Robert O'Donoghue, ‘The concurrent application of competition law and regulation: the case of margin squeeze abuses in the telecommunications sector’ (2005) 1 (2) Journal of Competition Law and Economics, 355, 370
92 are described to show how vertical integration may lead to enhanced or reduced efficiencies (depending on several factors). This is taken forward by assessing how vertical integration – when it is combined with market power in one of the levels – eliminates competition in the market where there was no market power previously.
Such practice may decrease consumer welfare even if integration otherwise increases the efficiency of the enterprise. This is may be a threat in the sectors concerned because of the network, which constitute a bottleneck.104
The theoretic background is followed by the assessment of legal solutions available (vertical separation to different degrees and access regulation) to enable efficiencies while preventing the leveraging of market power. Arguably the better is a solution in preventing the leveraging of market power the weaker it is in enabling for enhanced efficiencies. This part is followed by the description of the EU regulatory tendencies. Although in a sense the relevant EU policy is the starting point, by putting it here we can build on the previous points. In the next parts we compare these different solutions in practice. The paper describes the regulatory developments in the UK and Germany in detail. Assessing the regulations of these countries is informative as that they have generally opted for different solutions (the UK went for stronger separation while Germany opted for weaker solutions in both sectors), therefore they can serve as a good material for comparison.
After describing the different regulatory solutions applied, the next step is the assessment. The paper uses the incumbents’ market share as described in Chapter 1 and analyses it in light of the detailed case studies. Prices and consumer satisfaction data are disregarded since they are more remotely connected to vertical integration than market shares. In practice market concentration data is
104 Vertical integration between generation and supply, two competitive levels in the electricity sector is a somewhat different issue.
93 arguably the main indicator105 regulators and competition authorities rely on when analysing market power and competition on a market.