Juan Manuel Cruz1

I express my thanks for having the opportunity to address you on the topic of regulatory management and deregulation, and I express my special recognition to the host country, the Republic of the Philippines, and to New Zealand as convenor of this area, for the preparation and development of this workshop.

1. REGULATION, DEREGULATION AND PROMOTION OF COMPETITION: REGULATORY MANAGEMENT

After the first workshop on competition policy held in Auckland and the CTI meeting held in Manila last February, it was agreed that competition policy and deregulation should be merged in just one area. New Zealand prepared a concept paper, concluding that these two areas have strong linkages and that an integrated framework for them could be developed.

Just as an example, it is interesting to read the annual report on deregulation prepared by APEC Secretariat, and is easy to conclude that the same report, with the same contents, could well be a report on competition policy.

It is useful to draw initially our attention to one key statement on that document prepared after CTI meeting in February. It says that, as things have been emphasized, competition policy action plans focus on competition law, and that deregulation action plans focus on the removal of government regulations.

However, we all know that competition law is not enough by itself to assure free flows of trade and investment, as well as that the removal of government regulations is not enough to assure a competitive environment in the economy and an adequate protection of consumer welfare. In the case of competition law it could be said that having or improving it, is an objective by itself; but in the case of deregulation, maybe the removal of regulations is not an objective per se, and the relevant question is what kind of regulations we should have and how they are enforced.

So, I will state in this presentation that APEC economies should develop a comprehensive understanding of the instruments of competition policy and economic regulation in order to integrate them and make the best regulatory management possible, and achieve sound and stable regulatory regimes under the principles presented later. Under this principles should be easier to develop free trade and investment in terms of the Osaka Action Agenda, integrating public policy, international economic relations and private sector roles.

2. SCOPE OF REGULATORY MANAGEMENT

If we are to analyze regulatory management in the perspective of development and of the globalization of the economies, all instruments of competition policy and of economic regulation should be considered. The main task is to make all this instruments work in the same direction, including the action of the State and its institutional arrangements, in order to achieve a pro-competitive environment rather than consolidate some exemptions or isolated areas of the economy where the market does not operate properly. It has to be avoided the dynamic in which due to lack of competition the State regulates to protect consumers and welfare, but those regulations make impossible to develop competition later. This is a basic criteria to analyze and manage regulatory regimes.

In the next paragraphs I will present two main principles to continue this analysis: relation between competition law and special regulatory laws that establish framewoks for particular activities such as utilities or others, and the institutional arrangement of the regulatory function of the State.

After that, we will analyze in particular the principles that every regulatory framework should contain. That will make possible some analysis of the chilean experience and, finally, draw some conclusions and suggestions for further actions within APEC.

1. Competition law and specific regulatory frameworks

It is necessary to have special laws establishing particular regulatory systems, for example, for public utilities that are provided under a monopolistic condition. If we analyze the regulations for electricity, gas, water and other services to households, telecommunications and others, we should raise the question of how those special laws relate to competition law and how the enforcement agencies for competition may intervene in the regulation of such services.

The main objective of regulation, as it has been applied, is consumer protection and welfare in the form of maximum rates and minimum quality standards for services, and the enforcement of them. That is, in some systems the authority tries to determine what the prices should be if there were competition and that is fixed as a maximum rate that may be charged to customers for the defined quality of service. This could exclude those companies from a case of abuse of dominant position.

However, a complete study on a company's behaviour in the market could lead to the conclusion that there are multiple ways in which that company may lessen competition in its own and in related markets, may overcharge costs to consumers and may constitute additional barriers to entry into the industry. As markets and technological changes may be very dynamic, the only way to deal with these problems is establishing that the �egulated sectors�� are not excluded from the application of competition law.

There is a strong case for not making exemptions to competition law based, for example, on the fact that there is a special regulatory system or based on the fact that a company is state owned. It has been established as a general concept that the privileges of property rights (real or intellectual), may not be used to lessen competition.

It is very important to point that the competition law enforcement should be totally independent from the specialized regulatory authorities. Antitrust institutions that penalize anticompetitive behaviour and market structures that facilitate those conducts have an essential role to play.

2. Institutional considerations for regulatory institutions

From an institutional perspective, the first criteria is the separation of the regulatory functions from that of operating services, even if there are state owned companies. I would make a general statement saying that the state ownership of companies is not an efficient way to design or implement regulatory policy, nor it eliminates the need to develop good regulatory frameworks. In fact, a state owned company should be subject to the same regulations affecting a private company should be subject to the same regulations affecting a private company, on equal basis. From a competition policy point of view, the same case is also clear.

A second institutional consideration is that of the stability of rules and the independence of the regulator from political pressures. Private sector will not make investments in sectors where the price settings represent a risk of �dministrative expropriation��. This poses the question of how to restrain the excersive of the regulatory power, without meaning not to fulfill its objectives. The answer goes in the line of determining if regulatory framework is clear and detailed enough, and in the line of the mechanisms to solve the disputes between the regulator and the regulated. The first point is related to the existence of a adequate laws, and the second refers to the confidence that the judiciary will have capacity and independence to act properly in the case of those conflicts.

3. GENERAL PRINCIPLES FOR SPECIAL REGULATORY REGIMES

Government regulations are often themselves a source of monopoly power. Granting of exclusive rights to natural resources, sometimes granting legal monopolies in certain markets, prohibition to develop certain activities, are some examples that have to be analyzed in each economy. The same criteria should be used to analyze some situations created by several states that restrict supply, for example in international transportation.

In an open economy, the goal is to make national companies more competitive, rather than protect them by granting exclusive markets, special protections, or creating legal barriers to entry.

2.1. Non-exclusive concessions

Companies that want to provide public services require a special license or concession, that is, a special privilege given by the State. There are several reasons for that, ranging from the character of the service itself, to the necessity of using public and private property in the development of the activity. So, the license gives a special right to its holder to its holder to use other's property in its activity.

Of course, those special privileges go together with some obligations, the main being the obligation of service in a defined area.

The companies that have the concessions make big investments in the building and expansion of networks, there may be big economies of scale, there are important sunk costs, resulting a typical case of natural monopoly.

In this case, the first decision is about the character of those licenses that are to be granted. The general criteria should be to grant non-exclusive concession, and a regulation that guarantees that any person interested in one will get it just complying with the non discriminatory conditions established for each case. The authority is not to deny a license, even if it covers the same geographical area than another one.

It has to be noted that a bidding process, even if possible, is not the solution for the cases of utilities. It could be a good alternative in the case of the construction, operation and transfer of public infrastructure such as roads, ports, etc., because direct competition is replaced by ex-ante competition and not by an administrative privilege from the State.

To have non-exclusive concessions is a controversial point. In Chile we just had a very interesting situation with the introduction of natural gas coming trough a pipeline from Argentina. There were two different projects for this pipeline, both requiring concession, and besides that there were two applications for distribution concessions in the main cities. At one moment, the companies interested in the project made a strong argument in favor of having exclusivity as an essential condition to continue. Due to investment, sunk costs and other reasons, they said, the only way to make feasible the project from an economic point of view was to get exclusive rights.

As a matter of fact, two non-exclusive concessions were given, and there is no limit in granting new ones. The other fact is that the pipeline is being built under these rules, and finally, we could have more pipelines or more distribution networks in the future because there are no legal barriers to entry. In this case, we made a strong bet, because we really need natural gas as an energy source, but the principle is to structure markets right from the beginning. If regulations establish the right incentives, the market and the private sector will decide which project is the best, or which one is going to be built first, and no public official has to decide it. We believe that competitive efficiency (not allocative efficiency) is a better approach.

2.2. Open access and interconnections

A second point to analyze when there is a natural monopoly is the access to network and the connection between networks. Every time there is a natural monopoly, open access should be mandatory in order to avoid the extension of the monopoly power upstream or downstream. On the second point, interconnection has proved to be a key issue to avoid barriers to entry to the industry. If telecommunications continue to develop as it is developing now, maybe the only regulation for the future should be interconnections.

2.3. Vertical integration

The last criteria leads us to the analysis of vertical integration. Theoretically speaking, it should be avoided if the vertical integration includes a segment which is a natural monopoly. The first step, is to rule that certain activities should be the only one developed by one company. For example, electricity transmission should be separated from the other activities of the sector, generation and distribution. This criteria must be modified if there are big economies of scale or scope. The logic behind this is to rely on a competitive market rather than on the decisions of a regulatory authority as far as possible.

However, sometimes the separation of monopolistic activities is not enough if there are ownership relations between the companies formally not integrated. It is not easy to establish one single criteria to determine if it is acceptable that companies create subsidiaries to comply with the obligation of separating activities. In the case of Chile, I could argue that for the electricity transmission a complete separation and independent ownership of companies is needed. For telecommunications, however, given the technology status and the present market structure, and provided that there are not cross subsidies, it should not be a problem to have a local telephone company developing long distance service trough a subsidiary.

2.4. Cross subsidies

The existence of cross subsidies between services of the same company undoubtedly limit competition and doesn� induce the most efficient allocation of resources. If the reason for cross subsidies is to favor the poor, a more efficient approach is granting subsidies directly to those poor people, without affecting the efficiency on the supply side.

2.5. Transactions with related enterprises

Another aspect to look at are the transactions between a regulated monopoly and other non regulated related companies (related by common ownership). If the regulator is to determine the costs to provide a service in order to fix maximum rates, it is very difficult to discuss, for example, what the construction costs really should be when all the construction is made by a related company. The case is not theoretical, in Chile we have had this kind of discussion with private water companies. I have to remind that the �arket�� of building companies specialized in sanitary infrastructure is composed of a couple of firms. So, if a transfer is made from the regulated company to a non regulated related one, that is finally financed by consumers.

2.6. Horizontal integration

Horizontal integration is looked at in every market structure, and it is also important in this case. The problem is that high concentration prevents competition, specially if there is a vertical integration or ownership relations with natural monopolies. Again, the electric sector in Chile will provide us a good example.

Also, high concentration makes more difficult the regulatory activity due to the difficulty of obtaining reliable information, and to the risk of regulatory capture.

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4. SOME CASES OF THE RECENT EXPERIENCE IN CHILE

1.Telecommunications

Although there are many problems to solve yet, the experience of regulating and deregulating this sector has been a good one. Telecommunications companies were privatized by the end of the 1980�, and successive regulatory reforms took place. There was just one company with the rights to make international telecoms, and that was removed. The sector was opened to foreign investment and other measures of the kind were taken.

From a regulatory point of view, in 1993 the Resolving Commission, (Antitrust tribunal), ruled that CTC, the local telephone company for almost all the country, should stop to develop activities in the long distance market, although it could make them trough a subsidiary. The long distance traffic was being serviced then by two companies, ENTEL that had the exclusive rights to international traffic and a high share of domestic long distance traffic, and CTC. Both CTC and ENTEL had been public enterprises and were privatized without major regulatory reforms.

As a consequence of that decision of the antitrust authority, which had immediate effect, the government sent to Congress a new law that was approved by march 1994. It established the obligation to separate the activities of local and long distance communications, improved the regulations about interconnections, leaves to the Resolving Commission the power to decide precisely what activities should be regulated within the sector and to which ones maximum prices are to be set, and other aspects.

In October 1994 the multicarrier system began to operate with five companies competing in the market, and three more came in later.

The deregulation and competition in long distance caused a significant fall in rates. For example, in September 1994, just before the new system, a standard rate for a call from Chile to the United States was over US$ 2 per minute. By this time, rates are in the order of US$ 0.70 to US$ 0.90 in peak hours, and much lower, US$ 0.25 to US$ 0.30 off peak hours and on weekends.

There has been a big increase in traffic. International calls have increased from 6 million minutes a month before multicarrier, to around 12 million minutes a month.

Local telecommunications have also had a big development under the regulatory system. The number of lines has more than tripled in the last eight years, with a significant increase in quality of service. BY 1993, all lines were digital.

Finally, as technology advances, some competition in local telephone systems is beginning to develop. Of course, this is also so because there are non-exclusive concessions.

This has been a good exercise of regulatory management. Antitrust commissions played a central role, a law was modified, there were simultaneous advances in regulation and deregulation, and the outcome is resulting to be a more competitive sector, and a regulatory authority acting in a new way. As I said, there are big problems to solve yet, but competition has been promoted with a great degree of success.

2.Electric sector

The state owned electric company was privatized in 1986, after a new law for the sector went into effect in 1982. The chilean electric law is one of the best examples of marginal cost pricing, operation of the whole system at a minimum cost, incentives to improve efficiency in production which should result in lower prices to consumers, recognition of regulated household services and free market for big consumers, clear processes to fix maximum prices, etc.

The electric law was drafted assuming competition in generation and competition in the supplying of big consumers, while distribution and transmission are considered natural monopolies.

The development of the sector has been very dynamic. Demand for electricity has been growing over 8% a year and big investments have been made to supply that demand.

However, the situation presents some problems. Efficiency gains have been very significant, as well as returns of electric companies, but those increases in efficiency have not been followed with equivalent fall in rates to customers. Some of the reasons that explain this are part of the real market structure in the industry.

In the central electric system, the main one in the country, the same economic group controls about 65% of the generation, almost all of the transmission and about 65% of distribution. So, we have a case of horizontal integration in power generation, we have a strong case of vertical integration, and we have observed several conducts that may well constitute anticompetitive practices. For example, the main distribution company sighed a contract for buying all the power it needs during the next fifteen years with the related generation company. In some other cases, the technical characteristics of the connections of generators to transmission grids vary and they do not have equal opportunities to reach final customers. Although the electric law is very complex, it did not foresee every situation possible, and those situations may be used in favor of that one company due to the economic concentration and integration. In one word, lack of competition makes insufficient even the longest and more detailed regulatory system.

There are two ways in which the problem is being tackled. One is trough improvements in regulations, some of them requiring law modification. The other one is an investigation being developed by the Fiscalia Nacional Economica in order to get a resolution of the Antitrust Commission ordering to brake the vertical integration. The results of both actions are yet to be seen. I don� know of situations comparable to this one, except the one of British Gas when MMC ordered to brake the activities of trade and transportation of gas.

3.Water sector

The water companies are, in a vast majority of the cases, owned by the State. The government has decided to privatize them for several reasons, one of them being the requirements of huge amount of investment to provide the service to all the population, and particularly to finance the sewage treatment plants which have not been constructed.

This is not the opportunity to analyze this issue, but it is necessary to mention that the privatization will take place only after Congress approves a new regulatory framework for this sector. The modifications proposed include provisions on limiting horizontal integration, giving enough powers to the regulatory authority, regulating transparency of transactions between the water and sewerage companies and the related ones, creating new possibilities of competition when that is possible, imposing open access to the distribution network under strict technical conditions, and, in general, dealing with all the concepts disussed in this paper.

In the next months we will know how much of the proposal to Congress is approved. This has a very special meaning, because this is the main regulatory reform being developed now in Chile, and its outcomes could create better conditions for similar improvements in other sectors.

5. CONCLUSIONS AND EINAL REMARS

This presentation has been based on the experiences of Chile during the last decade on deregulation, privatization, regulation, and opening of the economy, both on trade and investment flows. Maybe some of the experiences I am sharing with you is relevant for other APEC economies and some is not, but there are some conclusions that may contribute to a faster approach to the final goals of APEC.

1.Regulatory management: deregulation, regulation and promotion of competition

The first conclusion is that a deregulation program has multiple complexities, just as a regulation program has. It doesn� matter if we prefer to speak of competition policy or of regulatory management. The only advantage of talking this last way is to emphasize the actions that are being taken or that have to be taken to have really free trade and investment flows by 2010 and 2020. Regulatory management is one of the key areas of public policy in an open economy and it should be understood by public authorities and by the private sector.

2.Free investment flows play a central role in deregulation

The effects of trade on competition have been analyzed with certain level of detail. However, the case of Chile shows that investment flows also play a central role in promoting competition in small economies. Just like trade may make more competitive the markets of goods, investment flows may make more competitive the markets of services and of non tradables in general.

3.Private sector involvement in regulatory management understanding and ability of the economies to use it as an input for their policy

The area of deregulation and promotion of competition represent big opportunities for small and medium enterprises, as well for big enterprises in the form of investments. Each economy by itself, and APEC economies as a whole should be able to test its policies by knowing the reactions of the private sector. When a project is done, the results are there, but when it is not done, we should be able to know the reasons for it. If those reasons are related to the regulatory environment of the economy, or to the market structure existing in one country, the worst situation is not knowing it. One request to PECC could be to collect permanently information on business opinions on these topics.