Theory of Regulation and Regulation of Industries Zdeněk Hrubý

Motto „If it moves, tax it. If it still moves, regulate it. If it stops moving, subsidize it.“ Ronald Reagan

Course Organisation and Contact Details Consultation hours: –Tuesday 3:30pm - 4:50pm Web page of the course Contacts: –Zdeněk –Pavel –Petr

Introduction: Aim of the course Provide a basic overview of approaches towards regulation: –Theoretical - Main economic and political economic approaches –Practical - EU Competition Policy Introduce various industry specific regulations namely: –Air Transportation –Electricity –Gas –Telecommunications –Environmental regulation –Financial and capital markets Lectures will be delivered primarily by external experts. Brief notes will be made available online after the lecture is delivered

Structure of the Course –Week 1 Introduction, Course overview, Motivation and basic theory overview –Week 2 Review of main theories and approaches towards regulation –Week 3 Financial and capital markets regulation –Week 4 Regulation cases from Czech financial and capital markets –Week 5 Electricity and gas markets –Week 6 Electricity pools

Structure of the Course –Week 7 Environmental regulation, experience of emissuion permits –Week 8 EU competition policy I –Week 9 EU competition policy II –Week 10 Telecommunications –Week 11 Air transportation

Do we need regulation? ???

Rationale for regulation –Monopolies and natural monopolies –Windfall profits –Externalities –Information inadequacies and asymmetry –Anti-competitive behaviour and predatory pricing –Unequal bargaining power –Public goods and moral hazard –Continuity and availability of service –Scarcity and rationing –Distributional justice and social policy

Disscussion on Goals of Regulation “Intervention in the market is often required to ensure that the pursuit of profit does not conflict with social welfare. Natural monopoly is the classic case” “The purpose of regulation is to ensure socially desirable outcomes when competition cannot be relied upon to achieve them. Regulation replaces the invisible hand of competition with direct intervention – with a visible hand, so to speak” “The central issue of regulatory economics is the design of mechanisms that regulators can apply to induce firms to achieve optimal outcomes” (Train, 1991)

Issues in Regulation Main issues: –What is the optimal outcome? –Do we need to regulate? –Can we design a regulatory mechanism that induces the regulated firm to act in a way that results in the optimal outcome? –Do we have to balance the benefits of regulation with its costs and risks, e.g. regulator’s capture?

Who regulates Parliament Governmental institutions Independent regulatory bodies European Commission Courts Self-regulation

Case 1: Natural Monopol PPrice QQuantity MCMarginal costs ACAverage costs MR Marginal revenues E m Monopoly equilibrium Dead-weight loss (DWL) Q P DMR EmEm MCMC AC

Case 1: Natural Monopol PPrice QQuantity MCMarginal costs ACAverage costs MR Marginal revenues E m Monopoly equilibrium E loss Equilibrium with no DWL Q P DMR EmEm MCMC AC E loss

Case 1: Natural Monopol PPrice QQuantity MCMarginal costs ACAverage costs MR Marginal revenues E m Monopoly equilibrium E loss Equilibrium with no DWL E nil Equilibrium with no profit Dead-weight loss (DWL) Q P DMR EmEm MCMC AC E nil E loss

Case 2: Telecommunications Universal service Public vs. private monopoly Deregulation vs. reregulation Role of fixed-line and mobile incumbents Dynamics of the environment –Innovations and technological progress –Internationalization –Changing behavioural patterns of consumers

Need of a multidisciplinary approach “If economists were to devise technically superb schemes of regulation these would come to little if no heed was paid to the warnings of those political scientists and sociologists who point our reasons why, in the real world, those schemes will not produce the ends the economists anticipated. Similarly, in looking at how such schemes can be implemented, lawyers’ messages concerning the limitations of different kinds of rules and enforcement processes should be taken on board.” (Baldwin, Cave, 1999)

Recommended literature Baldwin, R., Cave, M. (1999): Understanding Regulation, Theory, Strategy and Practice, Oxford University Press, Chapters 1, 2, 4 & 5