5.1 Why Regulate Prices?
Regulation has potentially high costs. Among other things, it substitutes the regulator’s judgment for market interactions. No matter how capable and well intentioned regulators are, they will never be able to produce outcomes as efficient as a well-functioning market. Regulators should therefore forebear from interfering in pricing decisions unless regulation is justified. That is, unless the expected benefits from regulating prices outweigh the expected costs from doing so. This requires that, without regulation, prices will either be: - Too high overall — if an operator or service provider has market power they may increase prices above competitive levels. This will suppress demand for the service, leading to a loss of social welfare, or
- Anti-competitive —an operator or service provider with market power may engage in pricing practices that hinder competition in a market. Three important anti-competitive pricing practices are cross subsidization, price squeezes, and predatory pricing.
Regulatory Options If there is a case for price regulation, a number of regulatory options exist. These include: Regulatory Criteria
The list below sets out common regulatory goals, which provide useful criteria for assessing regulatory options: - Prevent the exercise of market power: An important goal of regulation is to ensure that prices are fair and reasonable, where competitive forces are insufficient. Any regulatory price control mechanism should encourage prices that reflect what one would observe in a competitive environment,
- Achieve economic efficiency: The regulatory mechanism chosen should improve economic efficiency. There are several measures of economic efficiency:
- Technical efficiency (or “productive efficiency”) requires that goods and resources produced in the telecommunications industry should be produced at the lowest possible cost. This ensures that society’s scarce resources are used efficiently and are not wasted,
- Allocative efficiency requires that the prices one observes in a market are based upon and equal to the underlying costs that society incurs to produce those services (generally the long run incremental cost of producing the service). This will ensure that customers whose valuation of the service exceeds the cost of producing the service will purchase the service. Customers who place a lower valuation on the service will forgo it. This ensures that the “optimal” amount of the service is consumed, given cost and demand conditions. In the ICT sector prices must include some mark-up to recover shared and common costs. Mark-ups should be set so as to minimize the impact on allocative efficiency, and
- Dynamic efficiency requires that firms should have the proper incentives to invest in new technologies and deploy new services,
- Promote competition: Many regulators operate under a legal framework where the goal is to permit and promote competition in telecommunications markets. Where the legal framework permits competition, it is important that regulation (at a minimum) does no harm to competition,
- Minimize regulatory cost: All else being equal, regulators should choose a regulatory mechanism that is less costly to implement over one that is costlier to implement,
- Ensure high service quality: In addition to ensuring that the prices of telecommunications services are fair, regulators are also concerned that consumers should receive a high quality service. In ranking alternative regulatory options, regulators should give preference to mechanisms that result in higher quality service, all else being equal,
- Ensure telephone prices are competitive with other jurisdictions: This is a relevant objective in countries, such as Singapore, that use telecommunications infrastructure as a tool for competitive advantage. In these countries, telecommunications infrastructure plays an important role in attracting foreign investment. It is therefore important that telecommunications prices are competitive with other possible destinations for foreign investment,
- Generate compensatory earnings: Any regulatory mechanism should provide the regulated company with the opportunity to earn a reasonable profit and to achieve compensatory earnings. If not, the firm may be forced to reduce investment and quality of service may decline.
RELATED INFORMATION Pricing Principles for the ICT Sector
Setting the Level and Structure of Prices
International Benchmarking of Prices
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