Regulation friend of competition

By JOHN KAY*

Almost the first measure of market liberalisation introduced in Britain by the Thatcher Government 20 years ago was deregulation of the express coaching business.

The old rules required a new operator to show that his service was needed, a test which he would fail if the route was already served by someone else. A more comprehensively anti-competitive regime is hard to imagine.

When these restrictions were swept away, everyone expected that National Express, the publicly owned operator, would lose its market dominance.

The result was precisely the opposite. The largest competitor collapsed within weeks. The few entrants to succeed mostly ran their operations in partnership with National Express.

Analysis of this experience had an enduring influence on the design of privatisation and deregulation in the United Kingdom. Removing restrictions on competition does not ensure that competition happens.

The early results of liberalisation in gas and electricity supply were also disappointing. Statutory monopoly was abolished, but no new entry whatever occurred.

If an industry has a long history of dominance by a single firm, the process of introducing competition needs to be managed. You must regulate to deregulate.

National Express reinforced its market power in coaching services in two principal ways. The state-owned company owned or effectively controlled most city centre bus terminals.

When regulation was abolished, it was able to exclude private operators unless they agreed to operate joint services. No newcomer could contemplate building a new bus terminal in central London. It was only later, when National Express was forced to divest Victoria Coach Station, that competition in the key London services became effective.

And National Express matched any fare a competitor offered. If these fares were predatory, they were in breach of British competition law. But who knew whether they were predatory or not? Certainly not National Express, whose rudimentary accounting systems at the time did not enable it to measure the costs of running its various services.

Lawyers and economists could have debated the subject for years. They didn't, because no private coach operator could afford to fund the case.

It was salutary that this early experience happened in the coach business. There is probably no industry that is easier to enter than express coaching. Anyone can hire a bus and be running coach services tomorrow.

Compared with the scale of operations and investment needed in telecommunications or power supply, the obstacles to competitive entry in coaching seem insignificant. But even here the transition from monopoly to competition required management.

This experience has been repeated in other industries and other countries. Competition in telecommunications developed in Britain because the first telecommunications regulator, Bryan Carsberg, imposed a regime which simultaneously gave entrants access to the existing network and stimulated them to develop their own network capabilities, and the Government limited BT's ability to offer mobile services.

Today, Britain's largest telecommunications company is no longer the privatised BT. Nor is it the initially preferred entrant, Cable and Wireless. It is Vodafone, a company that did not exist before the process of liberalisation began.

The rapid introduction of competition proved better for consumers. It also turned out in the long run to be better for the former monopolies themselves.

British Gas was privatised as a single entity with light-handed regulation, while the electricity industry was fragmented into competing businesses under tighter supervision. It seemed that Dennis Rooke, who dominated Britain's gas industry for more than a decade, had won, while Walter Marshall, who sought to occupy the same position in electricity, had lost.

The verdict of history is the other way round. British Gas went through several rounds of challenges by the competition authorities, and escalating battles with its regulator.

The company once fought off a Monopolies Commission recommendation that it be broken up, only, in the end, to conclude that its only viable commercial strategy was to dismember itself voluntarily.

In contrast, Britain's new electricity companies adapted immediately to a competitive environment and developed their activities both in Britain and overseas.

The lesson is not that regulation is better than competition. "Competition where possible, regulation only where necessary" is an essential maxim for liberalisers.

The real lesson is that regulation is very often necessary to secure competition.

The objective of such regulation is not to fine-tune the process of competition. It is difficult for entrants themselves, and more difficult for regulators, to know whether newcomers will be more efficient than incumbents. It is certainly difficult to devise regimes which ensure that only efficient entry will occur.

But competition produces benefits whether the entrants are more efficient or not, because the principal gains from competition are the effects of rivalry on the performance of all operators, new and old.

Most entry into deregulated industries - telecommunications, power supply, airlines - has occurred not where the incumbent has the highest costs but where a history of political control has led to tariffs that are much too high.

These new entrants may have been no more efficient than incumbents at providing these services, and perhaps less so. It doesn't matter. Competition improves the performance and customer service of previously dominant firms anyway. In due course, the ordinary processes of the market will sort out which competitors, old and new, are efficient, and which are not.

Competition in the New Zealand economy is limited anyway by its remoteness and the small size of its market. But the experiment in light-handed regulation has led to less competition than is achievable - and has been achieved overseas - in overseas countries which have been willing to let regulators manage the process of introducing competition.

Once incumbent monopolies understand that the battle to maintain their dominance is a battle that they will lose, their priorities and responses are different: oriented to customer service, not strategic and political advantage.

It is monopoly, not government, which is the enemy of market forces. It is true that in the past monopoly often came into being because a Government promoted it. But it is true today that competition will often only come into being if a Government promotes it.

* John Kay is a British economist who writes a fortnightly column in the Financial Times.