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Primer on Access Regulation and Investment

Primer on Access Regulation and Investment

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Published by Joshua Gans
Joshua S. Gans and Philip L. Williams, "A Primer on Access Regulation and Investment", 18 March, 1998
Joshua S. Gans and Philip L. Williams, "A Primer on Access Regulation and Investment", 18 March, 1998

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Published by: Joshua Gans on Jan 18, 2010
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01/21/2010

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A Primer on Access Regulation and Investment
*
by
Joshua S. Gans
and 
Philip L. Williams
Melbourne Business SchoolUniversity of Melbourne18 March, 1998This paper reviews recent advances in regulatory theory concerning theeffect of access pricing regulation on incentives to invest in infrastructure.We demonstrate that regulation has a dual role of ensuring that investmentcosts are themselves shared by multiple users of a facility and that potentialproviders compete to invest in a timely manner. Our paper, therefore,provides a rationale for using fixed access charges to allocate investmentcosts so as to ensure timely investment and competition. 
*
We thank David Briggs for helpful comments. Responsibility for all views expressed in this paper lieswith us. All correspondence to: Joshua Gans, Melbourne Business School, 200 Leicester Street, CarltonVictoria 3053; E-mail: J.Gans@mbs.unimelb.edu.au; Fax: (03) 9349 8133.
 
2This paper provides a discussion of the relationship between access regulation andinvestment in essential facilities. Regulation of access terms and prices affects the return afacility provider can expect to receive on its investment. Hence, expectations of the natureof regulation affect investment incentives. A regulator, therefore, has the power toinfluence investment indirectly by pre-committing to an access pricing regime. However,uncertainty and inappropriate signals can potentially have an adverse influence oninvestment. So the regulator must take care when stating regulatory policy and applyingregulatory instruments.In Australia, Part IIIA of the
Trade Practices Act 
(1974), gives the AustralianCompetition and Consumer Commission (ACCC) the power to determine prices of accessto essential facilities. These powers are constrained somewhat, however. For example:
s44W(1): The Commission must not make a determination that would haveany of the following effects ...(d) resulting in the third party becoming the owner (or one of theowners) of any part of the facility, or of extensions of thefacility, without the consent of the provider,(e) requiring the provider to bear some or all of the costs of extending the facility (or maintaining extensions of the facility).
This indicates that the ACCC does not have absolute power to impose any form of pricing.In this paper, we wish to review how regulation affects investment in infrastructurethat involves sizable sunk costs. In particular, we suppose that the infrastructure producesits services by way of a natural monopoly technology. In addition to the sunk costs of itsprovision, there are constant marginal costs involved in its use. Moreover, theinfrastructure effectively has unlimited capacity. It is not certain that the ACCC has thepower to regulate access to such infrastructure. The
Trade Practices Act 
requires that inorder for a service to be declared it must be “uneconomic for anyone to develop anotherfacility to provide the service.” (s44G(b)) For a natural monopoly technology, a singleprovider is economically efficient. However, it may be commercially viable to duplicate thefacility allowing an entrant to bypass an incumbent. In this paper, we will cast a broad netconcerning the powers of the ACCC in this regard and assume that it can regulate the
 
3pricing of access to all facilities with a natural monopoly technology. As we demonstratebelow, regulation can improve social outcomes in this instance.Regulation serves to affect investment indirectly. By committing to an accesspricing structure that it will implement whenever access is sought, the ACCC influencesexpectations. Here we focus purely on the dynamic aspects of regulation and hence,assume that the regulator has complete information so that the optimal form of pricing takesto the form of a two part tariff (King and Maddock, 1996, Chapter 5). The first part of thetariff sets the usage charge equal to short-run marginal cost. Note that under incompleteinformation this is not necessarily the preferred solution (Laffont and Tirole, 1993;Armstrong, Cowan and Vickers, 1994; Vickers, 1995; and Armstrong, Doyle and Vickers,1996). Here, however, we abstract from such concerns to focus on dynamic issues. Thesecond part of the two part tariff sets a fixed charge for access. Under completeinformation,
 
the key regulatory choice that influences investment is, therefore, the choice of the fixed charge.The determination of fixed charges has always been a contentious issue inregulation. In the past, its choice has been seen as arbitrary -- essentially, redistributingincome from access seeker to provider -- without any real efficiency consequences.However, from the point of view of market participants, the level of fixed charges is acontentious issue. This is because providers realise that it affects the overall return on theirinvestments and access seekers realise it influences their incentives to enter markets andcompete with incumbents.We contend that the use of fixed charges can have a key role in determininginvestment incentives. To this end, whenever we refer to access charges below it willconcern only fixed charges. To have an effect on investment, regulation must modifyincentives. A higher fixed access charge raises the incentives of firms to invest. However,it cannot be too high or seekers might have an incentive to duplicate the facility. For

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