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Tuesday, 14 October 2014 02:36
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That’s what this year’s economics Nobel is about

Putting a regulator in charge of an inherently monopolistic market, such as telecom or electricity or even coal in India’s case as and when the market is opened up, is pretty much par for the course. The regulator, in turn, ensures there are no monopolistic/oligopolistic profits in a variety of ways which include price caps or rate-of-return pricing; in more recent times, with the advent of the Flipkarts, but going back to newspapers being given out for virtually free, there is the clamour for preventing predatory pricing—but how does giving out a newspaper free amount to predatory pricing if the resulting circulation build-up helps generate ad revenues which make the newspaper profitable? Determining the nature of the market, and applying a unique solution is what this year’s economics Nobel is all about; though it has been awarded to French economist Jean Tirole, some of his major work on the theory of regulation has been done along with the deceased Jean-Jacques Laffont. The duo’s work, using game theory, also dealt with the issue of asymmetric information—how does a regulator deal with a company on whose efficiency levels he doesn’t have complete information about?

Fixing caps on returns, say the 16% India allows in many areas like electricity, looks good but the problem is that it creates incentives for firms to gold-plate costs—this is the charge made in the case of large infrastructure projects like Reliance Industries Limited’s KG Basin gas field or the GMR Group’s Delhi airport project. Price caps put, such as by India’s drugs authorities also look like they are achieving a social goal, but when they end up, as they have, reducing the supply of medicines, that defeats the purpose—keeping profits low in the case of pharma patents may lower prices, but they may also lower innovation, hurting society in the long-term.

It is from this kind of work that several innovative solutions in regulatory theory have emerged. In the case of telecom, while price caps were the initial tools of regulators in India, they later started using the ‘long run incremental cost’ model to ensure all telcos had to offer inter-connection to even newcomers at this cost—once there was the possibility of more competition, the inherently oligopolistic market structure doesn’t matter as much. In electricity markets, while rate-of-return caps are still favoured, unbundling of markets and open access are seen as far more efficient tools. In long-distance telecom markets, in the US for instance, mandating that market leaders have to sell a certain proportion of their minutes to resellers is another innovative way to encourage competition. While the Competition Commission has done impressive work in dealing with oligopolistic suppliers, the important thing for it and other regulators to keep in mind, as Tirole and Laffont’s work show, solutions vary widely across industries and the old price/return cap solutions may cause more damage than good.

 

 
 

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