strategic choice of financing systems in regulated and interconnected industries
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Strategic choice of financing systems in regulated and interconnected industries. Liberalization and regulation. Liberalization of network industries Infrastructures are essential facilities Large returns to scale Huge fixed costs Investments Regulation of access railways, telecoms… - PowerPoint PPT PresentationTRANSCRIPT
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Strategic choice of financing systems in regulated and interconnected industries
Anna Bassanini Jerome Pouyet
Rome & IDEI CREST-LEI & CERAS-ENPC
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Liberalization and regulation
Liberalization of network industries
Infrastructures are essential facilities Large returns to scale Huge fixed costs Investments
Regulation of access railways, telecoms… to finance infrastructure
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Liberalization and globalization
Volume of international transactions using many networks
Competition on the markets
Interaction between regulations
Strategic impact of national regulatory modes/financing systems on international services
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Financing systems/regulatory modes
Railways in EuropePercentage of infrastructure deficit
covered by access revenue
Rmk: Only positive transfers Similar issues in other network industries
France Austria Germany
25% 40% 100%
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The questions
Nature of the interaction between the access pricing decisions of national regulators that face international services
Interaction between access pricing decisions affects the choice of financing systems
Nature/specificities of the regulatory competition between network managers
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Model - 1 Two countries, infrastructure manager IMi
International final services, q*(p*), requires the access to both infrastructures
First (budgetary) externality between countries
Net surplus S*(q*) is shared across countries: i+j=1 Second (direct) externality between countries
IMi decides: Access price a*i for the use of his infrastructure Transfer ti to finance the infrastructure
Downstream operators are competitive: p*=a*i+a*j+cd
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Model – 2
IM1
Infrastructure 1s.t. break-even constraint
Transfer 1Access price 1
Final sector:Final price/quantity depends on both access prices
IM2
Infrastructure 2s.t. break-even constraint
Transfer 2Access price 2
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Model – 3
IMi’s Budget Balance constraint
(BBi) : ti+(a*i-cu)q*(p*(a*1,a*2))≥ ki
IMi’s objective
SWi=i S*(q*)-(1+pf)ti+ti+(a*i-cu)q*-ki
Downstream Operatorsp*=a*i+a*j+cd
IMi : a*i and ti IMj : a*j and tj
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Ramsey-Boiteux Access Pricing Principles
Perfect cooperation between IMs (a*=ai*+aj* , t)
Optimal access price
Trade-off between the two instruments
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Simultaneous choices of modes of regulation-1
Transfers and access prices are decided simultaneously and non-cooperatively
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Simultaneous choices of modes of regulation- 2
Given a*j,
Strategic interaction
Transfer in country i
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Simultaneous choices of modes of regulation- 3
• Hyp:
• Stable & unique equilibrium
• Access prices excessive
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Assumptions on infrastructure costs
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Simultaneous choices of modes of regulation- Positive subsidy only-1
IMi chooses ti=0
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Simultaneous choices of modes of regulation- Positive subsidy only-2 Consider that
• Multiple equilibria
• NS-equilibrium unstable• S-equilibrium is stable
• Access prices are lower in the NS-equilibrium
• Similar features when access prices are strategic substitutes under the subsidy-system
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Strategic role of infrastructure costs in the NS-equilibrium Why are the access prices lower when both
infrastructure managers adopt the no-subsidy financing system? Infrastructure fixed costs act as a commitment device to
behave `aggressively’
• Therefore, IMs might have poor incentives for cost-minimization under the NS-equilibrium
• Scope for a strategic use of investment
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Impact of supra-national policies aimed at developing international services
• International services are excessively charged
• Standard solution: subsidize the acess to infrastructures to soften the distortions
• But, the impact of such policy depends on the equilibrium!
• Subsidies to infrastructures must be contingent on the regulatory modes implemented in the countries
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Sequential choices of financing systems-1
The mode of regulation has a commitment value It binds the infrastructure managers in the access
pricing decisions
Can countries use the mode of regulation in order to improve welfare? Two-stage game:
Choices of modes of regulation Choices of access prices
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Sequential choices of financing systems-2
Resolution by backward induction
Given financing systems in both countries, determine the access prices Immediate
Analysis of choices of regulatory modes Given the financing system in country j, what is
the preferred financing system in country i? The choice of financing system has two effects:
Direct effect: on the access price set in country i Strategic effect: on the access price set in country j
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Best-response in financing systems- Remark
Infrastructure manager distorts access price (reduces consumers’ surplus) to ensure the financing of infrastructure (increase the infrastructure profit)
To satisfy a strict budget constraint in a non-cooperative setting: Either reduce the access price to increase demand Or increase the access price to increase the margin Which strategy is chosen by an IM depends on the reaction of
the other IM
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Best-responses in financing systems- 1
Country j chooses No-Subsidy
(S,NS)(NS,NS)
• If one country chooses No-Subsidy, the other country chooses No-Subsidy
• The commitment to a strict-budget balance creates a strong strategic complemen-tarity, which provides an IM with an incentive to adopt the NS-system in order to reduce access prices
• This holds whatever
• (NS,NS) always an equilibrium
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Best-responses in financing systems- 3
Country j chooses Subsidy and
• If one country chooses Subsidy, the other country chooses Subsidy
• Multiple equilibria in the strategic game
• Infrastructure managers are `conservative’
• An IM is willing to reduce the access price onlt if he anticipates a sufficiently strong decrease of the access price set in the other country
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Best-responses in financing systems- 4
Country j chooses Subsidy and
• If IMi chooses NS, then a*i increases
• Then, IMj reacts by decreasing a*j, but to a smaller extent
• Total access price increases
• IMi saves on the subsidy given to the infrastructure under S but reduces consumers’ surplus
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Best-responses in financing systems-4bis
Country j chooses Subsidy and If the strategic reaction in country j is strong:
Country i chooses NS and total welfare decreases But then country j will also choose NS
NS in both countries is the unique equilibrium of the strategic game!
If the strategic reaction in country j is weak: The choice of financing systems depends on the
infrastructure fixed cost: ki small: Incentive to free-ride and choose NS
Unique equilibrium ki large: No incentive to free-ride and choose S
Multiple equilibria
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Strategic choices of financing systems- Summary
Financing systems might be used as a coordination device and enable the infrastructure managers to reach the Pareto-superior equilibrium However, infrastructure managers might have free-
riding incentives
Issues Renegotiation-proofness Incentives in presence of domestic and international
services
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Strategic choices of financing systems- Renegotiation-proofness
• Ex post, an infrastructure managers might be tempted to deviate from his equilibrium access price
• Financing systems must credibly commit the infrastructure managers
• Separation of access pricing and choice of regulatory mode
NS-equilibrium
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Extensions- 1Domestic and international services
Consider that services are purely domestic No externality between infrastructure managers No distortion wrt 1st-best perfect cooperation case
If international services > domestic services: Whatever the `initial’ choices of regulatory modes,
infrastructure should to be less subsidized Role of a supra-national authority to coordinate
the transition
If international services < domestic services: No mandatory adoption of no-subsidy
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`Pass-through’ country- 1
Consider j=0 Budget constraint never binding in this country Since taxation is distortionary, tj=0 Then:
Analysis similar to the choice of regulatory mode in one country when the other country chooses subsidy… except that…
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`Pass-through’ country- 2
Whether the budget-constraint is binding might be endogenous
When a*j is sufficiently low, the budget constraint might not be binding in country i
This creates the possibility of another equilibrium in which the budget constraint is not binding and access prices are low
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Conclusions Interaction between infrastructure managers with
direct and budgetary externalities Commitment to strict budget balance binds
infrastructure managers to behave aggressively
Potential coordination problems No-subsidy is Pareto-superior but unstable Subsidy is Pareto-inferior but stable
Supra-national policies to promote international services through infrastructure subsidies might have perverse effects
Financing systems might be used strategically to free-ride
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Further research
Strategic role of investment
Interconnection
International competition and the incentives for cost-minimization (agency problem)