An introduction to infrastructure services

Presentation outline  key characteristic of infrastructure industries economies of scale and/or scope  GATS disciplines on infrastructure industries  additional challenges for successful trade policy reform in infrastructure industries  how international trade negotiations can contribute to successful outcomes

Economies of scale  Definition A single firm can produce all output more cheaply than two or more firms  Policy dilemma Introducing competition may raise total costs per unit of service delivered – technical inefficiency Having no competition may allow the incumbent to restrict quality or quantity and raise prices above cost – allocative inefficiency

When do economies of scale arise?  Fixed costs – costs that are independent of usage Costs of maintaining local loop Costs of running airline reservation system Costs of maintaining electricity transmission lines → Total costs per unit lowest when only one firm incurs the fixed costs  Network economies Easier to optimise operating costs (relative to usage) in a larger network than a small one

Economies of scope  Definition A single firm can produce a group of services (eg local and long distance calls) more cheaply than two or more firms  Can arise when both services share the same fixed cost elements  Policy dilemma Introducing competition in one service (long distance calls) may lead to technical inefficiency Having no competition → allocative inefficiency

Policy provisos  Definitions apply to a given technology - there may be competition from alternative technologies road vs rail transport cellular vs fixed line telephony  The threat of entry may discipline pricing market contestable if there are no sunk costs, ie costs that cannot be recovered once committed  location specific sunk costs are common in infrastructure industries → inefficient duplication less likely, but monopoly pricing a problem

GATS disciplines on natural monopolies  Monopoly providers bound by general most- favoured-nation commitment  Monopoly providers bound by specific commitments, where these are made, on market access and national treatment in the monopoly market in markets where the monopoly supplier competes in the supply of a service outside the scope of its monopoly rights

What the GATS does not cover  The GATS is silent about the behaviour of a natural monopolist who has critical upstream or downstream linkages to markets where specific commitments are made Where competitive suppliers have to rely on a monopolist to provide a critical input eg telco operators need access to the local loop Where competitive suppliers have to sell their service to a monopoly distributor eg electricity generators need access to the national transmission system

Challenge for trade policy reform  Liberalising commitments in markets immediately upstream or downstream from a natural monopoly need supporting domestic regulatory reforms to ensure access to the monopolist’s essential or bottleneck facility  Otherwise the monopolist could use its control over the bottleneck facility to thwart competition in the upstream or downstream market

Elements of successful trade policy reform  Decide which parts of the network are natural monopolies  In the monopoly service Competition for the market can ensure lowest costs and best technology (though pricing still a problem) Foreign suppliers could bring better product and process technologies  In downstream markets Need access regime to ensure downstream suppliers get access to the monopoly input on reasonable terms  In upstream markets Need an access regime to prevent holdup and refusal to deal

Universal service obligations  funding USOs other than through cross-subsidies built into the incumbent’s retail price structure Allowing the monopolist to meet USOs and cover fixed costs efficiently through other means  → the monopolist will not need to inflate the access charge  → competition will be more effective

Role of international negotiations  Allowing foreign operators to compete for the market (monopoly service) or in the market (competitive upstream or downstream market) may offer better economic performance  International commitments can lock in current domestic reforms, add credibility to future domestic reforms  Countries can tap into the regulatory expertise of their trading partners → trade in regulatory services?  International negotiations can produce model regulatory regimes eg Reference Paper on Telecommunications