News Colm McCarthy

Wednesday 3 September 2014

Irish Water must be controlled with protection of the consumer in mind

Regulation of monopolies has become a toothless ritual and the time is long overdue to make changes

Colm McCarthy

Published 02/02/2014 | 02:30

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BACKLASH: Most houses won’t have meters installed when the water charges begin
BACKLASH: Most houses won’t have meters installed when the water charges begin

The controversy over Irish Water and its encounters with the Oireachtas committee system these last few weeks have barely scratched the surface of an ongoing problem in Irish economic policy, namely the regulation of monopolies.

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Nobody is free, in theory anyway, to impose excess costs on the public through lax management of a public utility. Running a company with lots of keen competitors is hazardous for the senior managers. In normal businesses, those pesky competitors improve products and services, cut costs and prices, run clever marketing campaigns and generally squeeze the fun out at every opportunity. Customer loyalty cannot be relied on. The customer will bail out at the first sniff of a bargain and will hail your rival as a hero. Rivals can even out-compete to the point where your business goes wallop.

It is more comfortable by far to choose a career in a business where there are simply no competitors. Unless government regulators get in the way, running a monopoly is just about the dandiest job in business, with the possible exception of running a bank in the good old days. Monopolies enjoy automatic customer loyalty, since the customers have nowhere to go. Excess costs can be incurred, including the costs of a happy and contented workforce, profits can be posted and dividends paid. Mistakes, such as foolish investment projects, can be glossed over and the bill passed along to the captive customers, who will grumble but cannot desert.

It has been understood since Adam Smith invented economics that monopolies are bad for consumers, so when politicians hear consumer grumbles they pass anti-monopoly laws, competition acts and the like. Sometimes competition is just not possible. It makes no sense to have duplicate or triplicate companies in certain sectors of economic activity, including some key activities.

There is just one network of electricity supply lines, just one gas pipeline system; most cities have just one airport, most regions just one seaport. These industries are the so-called 'natural' monopolies, often owned by government. Where competition is not possible, governments appoint independent statutory regulators, who are supposed to replicate the pressures of competition and keep prices down. Indeed statutory, independent regulators for certain natural monopolies are mandated by EU rules. The regulators in turn are hopefully kept up to scratch by the politicians and the consumer interest is protected.

Sadly the system of independent regulation of monopolies in Ireland is not working. The politicians appear unable even to recognise what has happened and the scrutiny at the Oireachtas committees gets easily diverted into side-issues, including ludicrous demands that government ministers should 'micro-manage' large utility companies.

The regulation of monopolies is not simple. The way it is supposed to work goes something like this. The company is not free to set prices wherever it wishes. Instead statutory bodies, such as the Commission for Energy Regulation, must approve price levels in advance. The regulated body, say the gas pipeline company, a natural monopoly, must submit its plans, including plans for capital spending and a budget for operating costs, to the regulator in advance, and the regulator then sanctions a permitted maximum price level. If the regulator is alert, no monopoly profits can be extracted, while excess cost will be spotted and disallowed.

Vigilant regulators with the right mandate should be able to protect the captive consumers, who are denied the normal defence mechanism of deserting to an alternative supplier when faced with rip-off prices. In Ireland and in many other countries, the prices charged by electricity and gas companies, fixed-line telecom companies, airports and several other businesses deemed to possess monopoly pricing power are capped in advance, usually on a five-year cycle, by independent statutory regulators.

The regulators are powerful people. In theory they can condemn a profligate and inefficient monopolist who seeks to gouge the public through unjustified prices to a five-year purgatory of heavy losses. Instead of agreeing the monopolist's requested price of, say, €5 per unit, they can adjudicate a more reasonable figure of €4 and let the shareholders take the hit. In Ireland this has rarely happened. The regulated monopolies are mainly state-owned companies and a culture has grown up of cost-plus pricing, where the regulator tots up the bill emerging from the monopolist's spending plans and sanctions the pass-through of these excess costs to the captive customer. The real issue with Irish Water is the manner in which the new company is to be regulated, and the threat of a cosy system of cost-plus pricing.

When regulators merely add up the monopoly costs and pass them along to the trapped customers, who have nowhere to go, there may as well be no regulation at all. An unregulated monopolist would simply announce the new price, declare it to be reasonable and let the customers go hang. In a healthy system of regulation-with-teeth, some of the regulated companies should from time to time be faced with price caps below what they seek to cover excess costs and be forced to bear the consequent losses.

In all of the discussion about Irish Water, the legislators have been silently assuming that any excess costs, for example from retaining unnecessary local authority staff for the next 12 years, will be faithfully reflected in water bills. In this they are unfortunately likely to be proved correct.

The Irish system of regulation for the various monopolies has never disallowed excess costs to the point where the monopolist was forced into major changes in behaviour. In this sense it is a pointless process and does not protect consumers as intended. The system is statutory; in other words the handiwork of the self-same legislators who rail against the expected high costs at Irish Water. A proper system would work like this: any regulated body which did sweetheart deals with trade unions or any other suppliers, or which unwisely burdened itself with too much capacity, would face dire financial consequences, just like in the real world with real competitors. Regulators of monopolies are supposed to mimic the pressures that would normally be created by competition. This is not easy and regulation will never be an exact science but the Irish version has become a toothless ritual and it is time to make some changes.

Regulators of monopolies are worthless unless they place the consumer protection role up front and centre. Ultimately, the protection of consumers, otherwise at the mercy of monopoly utilities, is the reason why the regulatory system was created. They should see themselves as benchmarking bodies whose principal task is to dis-allow costs beyond what is reasonable. If all they do is pour legitimising holy water on the pass-through of cost inefficiencies, the entire exercise is something of a charade. The most effective role for parliamentary committees would be to inspect the performance of the regulators, and to review the suitability of the legislation under which they operate.

The regulated bodies are almost all state-owned companies. The regulators are statutory off-shoots of the same government department which owns the regulated body. Thus the ESB, some of whose activities are regulated, belongs to the Minister for Energy. Supposedly to protect consumers, it is regulated by an independent body which reports to none other than the Minister for Energy. To make things even more incestuous, the regulators' budgets are provided by the regulated entities. All regulators in Ireland should report to a government department other than the one that owns them. The obvious choice is the department responsible for consumer matters, the department of Enterprise and Employment. The regulators should be funded out of the general exchequer and not beholden to the bodies they are supposed to police.

Some people argue that state-owned monopolies will never be aggressively policed by state-owned regulators, and that privatised monopolies would face tougher tests. Maybe so, but these companies are likely to remain in the state sector for a long time, perhaps for ever, and the built-in conflicts of interest in the current system need to be addressed.

This would be a nice agenda item for a parliamentary committee. After all, the regulators are creatures of statute, and Dail deputies are legislators who create statutes. The last few weeks of promenading about the alleged sins of Irish Water reflect poorly on the committee system. If there are flaws in the system of monopoly regulation in Ireland, and there are, the responsibility for fixing the system rests unambiguously with parliament.

Irish Independent

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