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Every-Palmer, James --- "The State and Monopolies: New Zealand's Experience" [2010] OtaLawRw 1; (2010) 12 Otago Law Review 227

Last Updated: 25 February 2012

^{F W Guest Memorial Lecture: 22 July 2009}

The State and Monopolies: New Zealand’s Experience

Dr James Every-Palmer¹

Introduction

It is 17 years since I sat, as a student, in this lecture theatre. I haven’t the slightest idea what that last lecture was about. I can, however, clearly recollect the three F W Guest Lectures I attended: Colin Withnall QC on tortious liability, Sir Ken Keith on philosophies of law reform, and finally Justice Bruce Robertson on the right to silence.

I remember these lectures not only because a 5.30pm start caused havoc with our flat cooking roster, but also for their quality and willingness to challenge the status quo. Accordingly, it is both a great honour and a bit intimidating to become a speaker in this lecture series.

Before I start, I want to acknowledge a huge debt of gratitude to the late Richard Sutton. No teacher has influenced me more and I feel exceptionally lucky when I hear his voice in my inner monologue. I am sure that for all of us who were taught by him, we would stop asking questions a lot sooner were it not for his influence.

Richard would have politely described the title of this lecture as a “little grandiose” and “yet somewhat vague”. So let me be a little less grand and a little more specific.

This evening I want to explore the changing balance between free market principles and state control of monopolies in New Zealand using the telecommunications and electricity industries as my main examples. There are a number of reasons why governments regulate markets. In the case of monopolies (or companies with market power), the main issues are usually the risk of “excessive” pricing and the risk that the company will act so as to discourage competition to protect its privileged position.

There are always debates about the meaning of “monopoly” and whether a particular company has “market power”. However, I think we can avoid these issues this evening by taking it as a given that in the telecommunications, electricity, gas distribution, rail, airport and similar industries, there may be concerns that normal market forces might not ensure that prices are fair, reasonable or “competitive”. This risk arises

¹ Partner, Russell McVeagh, Wellington. This paper was given as the F W Guest Memorial Lecture at the University of Otago on 22 July 2009. The views expressed in this paper are my own personal views, however, by way of disclaimer, I note that I act for various participants in the industries referred to. I wish to thank a number of Russell McVeagh solicitors and summer clerks whose research formed part of this paper, in particular, I am grateful to Kate Wevers, Emma Peart, Erin Morriss, Rupert Rouch, Ali Van Ammers and Muneya Shino.

because these industries, or some parts of them, involve infrastructure which is uneconomic to duplicate. So, we are unlikely to see a second electricity line strung to each flat in North Dunedin, and we are unlikely to see a second airport in Dunedin (and landing in Christchurch or Invercargill is not a particularly good substitute). With only a single provider, customers lose the ability to “shop around”.

A second problem is that “interconnection” disputes are common in these industries. They arise where a potential new entrant requires access to the incumbent’s assets or network. For example, for TelstraClear to compete against Telecom, it must reach an agreement with Telecom allowing its customers to talk to Telecom’s customers.

The regulation of these sorts of industries is complex and causes issues all over the world. New Zealand, however, is a particularly interesting case study because of the radical changes which have taken place over the last 25 years.

I will cover four issues tonight:

Part 1 covers the introduction of “light-handed” regulation in New Zealand between 1984 and 1990. During this time we went from very heavy State intervention to a laissez-faire market economy. In Part 2 I look at the role of the Courts during the light-handed era. Part 3 provides a whistle-stop tour of new regulatory measures introduced since 1999, and in particular, the forms of price control that have been imposed in relation to parts of the electricity, gas, telecommunications, banking and dairy industries. Finally, in Part 4, I will share some reservations about where we have ended up as a result of this re-regulation. I also have two reform ideas to propose. First, we should consider a Regulatory Reform Commission to address regulatory matters in a more pro-active, systematic way. And second, regulatory decisions should be subject to greater rights of appeal than is currently the case, to ensure robust processes and quality decision-making.

1. Introduction of light-handed regulation

The Lange/Douglas Government was elected in 1984. Back then, New Zealand was a very different place. In short, there was a lot of State and not much market. Regulatory controls were extensive, exports were subsidised, co-operative producer boards had statutory export monopolies, the exchange rate was set by the Government, and imports were subject to high tariffs. The prices of many goods and services were directly controlled; there had been six general wage and price freezes between 1968 and 1984. Local and central government-owned companies were directly involved in banking, transport, energy, tourism, insurance, forestry, computer services, broadcasting, and film-making. Many enjoyed statutory monopolies.

In terms of the telecommunications and electricity industries, regulation was via State ownership – which is as heavy handed as you can get. That is, the “problem of monopoly pricing” was “solved” by the State owning the business and setting the prices. The “problem of

interconnection” was solved just as bluntly, by prohibiting competitive entry. The “problem of investment” was solved by a mix of bureaucratic and political decision-making. The telecommunications system was part of the Post Office. And phones mainly came in beige.

Ownership of the electricity industry was split between (a) the Ministry of Energy which owned and controlled most generation assets and the national grid, and (b) a series of publicly owned electricity supply authorities which distributed and sold electricity locally. So, in Dunedin, you bought your electricity from a statutory body known as the Otago Electric Power Board. The electricity was probably generated somewhere along the Clutha river and transmitted to Dunedin by the Ministry of Energy.

The financial performance of these State entities and of the economy as a whole was very poor. In 1986 the $20b worth of assets (and that is in 1986 dollars) managed by the main State enterprises (including the Post Office and the Electricity Division of the Ministry of Energy) made no net return to the Government.² At least partly as a result of the regulatory environment, New Zealand had experienced a decade of poor growth and rising debt.

In response, the 1984 Labour Government initiated a profound series of reforms aimed at reducing the role of Government in business, promoting competition and strengthening the role of markets in determining prices and allocating resources.

In terms of the industries we are focusing on:

• The public telecommunications system was transferred from the Post Office to a state owned-enterprise (SOE) – Telecom Corporation of New Zealand Ltd in 1987. Statutory barriers to competition were removed (April 1989), and the Government sold its shares in Telecom to private interests (September 1990).³ And so a free market in telecommunications was born.

• Deregulation of the electricity industry occurred in a number of steps and over a longer time period (indeed extending well into the subsequent National Government). The transmission and generation functions of the Ministry of Energy were transferred to an SOE (Electricty Corportation of New Zealand) in 1987. Subsequently, the transmission function was transferred to another SOE (Transpower) in 1994, and by 1999 the generation function had been split between three SOEs (Meridian Energy, Genesis Power and Mighty River Power) and a publicly listed company (Contact Energy). At the same time, local electricity supply authorities were

² Jennings S, Cameron R “State owned enterprise reform in New Zealand” in Bolland A, Buckle R (eds) Economic Liberalisation in New Zealand, (Allen and Unwin, Wellington, 1987).

³ A single share (the “Kiwi Share”) was retained by the Government. It was used to impose coverage obligations, limit price increases for certain residential services and preserve a “free local calling” rental option.

corporatised and then required to choose to be either a distribution company or a retailer from April 1999. The idea was to separate out potentially competitive functions (generation and retailing) from the natural monopolies that exist in relation to national transmission and local distribution.

The approach to regulatory design was to remove the barriers to competition that had been developed over the previous decades and start with a light-handed or “market-based” approach. The primary focus was on “regulation through competition”.⁴ Policy makers embraced “contestability theory”, that is, the idea that if barriers to entry were minimised then new entry (or the threat of entry) would constrain anyone with market power from exercising that power.

The three main elements of light-handed regulation were “generic competition law”, information disclosure requirements, and the threat of further intervention such as price control.

Looking at each of these in turn:

A. Generic competition law

This refers to the rules in the Commerce Act 1986 that are designed to ensure independent rivalry in markets.⁵ The Commerce Commission is the main enforcement agency, although private plaintiff actions can be brought too. It is important to be aware that the Commerce Act does not make it illegal for a monopoly to recover “excessive” profits. The main statutory limit on unilateral conduct by a monopoly is found in s 36, which makes it illegal to take advantage of market power for the purpose of inhibiting competition. Merely recovering monopoly profits is not a breach of the Act. Rather, s 36 is aimed at predatory pricing, refusals to deal, bundling practices and the like.

⁴ The spirit of light-handed regulation is summed up by this quote from

^{Peter Allport when he was the Chair of the Commerce Commission in}

^{1998 “Natural Monopoly Regulation in New Zealand”, (paper presented}

^{to Institute of Public Affairs Deregulation Conference, 24 July 1998, at}

^6):

^{“Light handed” regulation provides an attractive, less economically}

^{distortionary alternative to heavier forms of regulation with the}

^{associated industry-specific regulatory bodies and higher compliance}

^{costs. For example, direct regulatory control imposed by an industry-}

^{specific regulator can generate itsown inefficiencies including the}

^{costs of operating the regulatory body, the information supply}

^{costs imposed on the regulated firms, and the compliance costs}

^{arising from the distortions caused by imperfect regulation. The}

^{possibility of “regulatory capture” is often noted as another possible}

^{concern; that is, where the regulator is “captured” by the regulated}

^{with the monopoly firms influencing the regulator to their own}

^advantage.

^{5 These rules (i) prohibit collusive agreements such as price fixing, (ii)}

^{prohibit a firm with market power from mis-using it, and (iii) prohibit}

^{mergers which are likely to lessen competition.}

^{B. Information disclosure}

In various industries where there were concerns about the possibility of excessive pricing, information disclosure rules were put in place (for example, Telecom in 1990⁶ and electricity lines companies in 1994⁷). The idea was that transparency would impose a discipline, because any monopoly pricing would be revealed.

C. Threat of further intervention

The third aspect of light-handed regulation was the threat of heavy- handed regulation. That is, while light-handed regulation was the new starting point, it was not necessarily the end point for economic regulation of utilities. The idea was that a credible threat of price control could be as good as imposing price control (and a lot cheaper). To this end, Part 4 of the Commerce Act contained a regime whereby price control could be imposed. The basic process would be a Commission inquiry, imposition by the Minister and implementation by the Commission. So, while it was not illegal to make monopoly profits, the risk of doing so was that you might find yourself subject to price control under Part 4.

2. Light-handed regulation and the Courts

Since the introduction of the light-handed regime, Courts have been asked on a number of occasions to help resolve connection disputes and step in on pricing issues. The parties seeking the Court’s interference have been largely unsuccessful, with the Courts refusing to assume the role of a price regulator.

Let me discuss three illustrative cases.

A. Telecom v Clear⁸ – section 36

The first new entrant after the telecommunications market was de- regulated was Clear Communications (a predecessor of TelstraClear). One of the ways Clear wished to compete was by offering a “toll bypass” service. Essentially, you were still a Telecom customer, but you could dial a prefix – 050 – for toll calls. This told Telecom’s switching equipment at the nearest exchange to transfer the call to Clear, Clear would carry the call from Dunedin to Wellington say, and hand the call back to Telecom to connect it to the intended recipient. Clear and Telecom ended up in a long running dispute over the how much Telecom would charge Clear for originating and terminating calls.

To use a highly simplified example, suppose that Telecom’s price for a toll call from my old flat in Dundas Street to Wellington was $1 per minute, and that this was composed of:

• 50 cents for the origination and termination of the call and other overhead costs (including Telecom’s return on capital);

⁶ Telecommunications (Disclosure) Regulations 1990.

^{7 Electricity (Information Disclosure) Regulations 1994.}

^{8 Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995]}

^{1 NZLR 385.}

^{• 30 cents being the cost for carriage from Dunedin to Wellington;}

• 20 cents of “monopoly profit” (ie the return above a normal profit).

In essence, the issue before the Courts was whether Telecom could charge Clear 70 cents per minute for starting and finishing the call (that is, Telecom’s lost revenue $1 minus the cost saving from Clear carrying the call between Dunedin and Wellington) or whether it should be limited to charging its actual costs, that is, 50 cents. The 70 cent calculation was based on the Baumol-Willig rule named after Telecom’s expert economists who formulated it. Clear challenged the Baumol-Willig rule under s 36 of the Commerce Act.

The Court of Appeal sided with Clear. The sentiment was summarised by Lord Cooke, then President of the Court of Appeal, who held that the Baumol-Willig rule was clearly anti-competitive since it would “amount to allowing a new entry into a market on condition only that the competitor indemnify the monopolist against any loss of custom.”⁹

The Privy Council took a different approach. Their Lordships focussed on the distinction between competition laws and regulatory price control. That is, the problem of monopoly could be tackled either by a regulatory body controlling prices after due investigation or by fostering competition to create efficient outcomes over time. Given that the Commerce Act had one set of provisions designed to foster competition (including s

36) and another aimed at price control (ie Part 4), it was, in the Privy Council’s view, wrong to use s 36 as a quasi-regulatory system. So while an outright refusal to provide access to a competitor might amount to a breach of s 36, the Court did not think it was appropriate to perform the role of a price control regulator under s 36.

I will deal with the next two cases much more briefly as they reach similar

^{results for similar reasons.}

B. Vector v Transpower¹⁰ – Prime necessity

Prime necessity is an old common law doctrine which requires a monopoly supplier of an essential service to make the service available to all-comers and charge no more than a reasonable price.

Vector (the owner of the local electricity lines business in Auckland) sought to use the doctrine to challenge the charges set by Transpower (the SOE that owned and controlled that national grid). Vector claimed that Transpower ’s charges were unfair, too high and inefficient: in other words, another classic utility industry pricing dispute.

The Court of Appeal, however, struck out Vector ’s claim. The Court (Richardson P on behalf of himself, Gault, Blanchard and Tipping JJ) held that although the doctrine had been part of the law of New Zealand, it had been impliedly repealed by the enactment of the Commerce Act,

⁹ Ibid, cited by Lord Browne-Wilkinson, at 401.

^{10 Vector Ltd (formerly Mercury Energy Ltd) v Transpower New Zealand Ltd}

^{[1999] NZCA 167; [1999] 3 NZLR 646.}

^{and in particular Part 4 of the Act since 1986.}

Following a similar approach to the Privy Council in Telecom v Clear, the Court held:¹¹

Price control through the Courts is a form of state control. The only state control of prices contemplated by the legislation is provided for within Part IV and is available only if and when the criteria contained in Part IV are satisfied.

The Court then referred to the Part 4 processes – initiation by the Minister, declaration of control by the Governor-General, and implementation by the Commerce Commission, not the Courts – and concluded that “it is inherent in those features of the statutory scheme that Part 4 is the exclusive means of achieving price control over the transmission of bulk electricity by Transpower”.

C. Air New Zealand v Wellington International Airport¹² – Judicial review

The third case I want to mention is a decision from the Court of Appeal in June 2009. It is a recent case, but deals with legislation from the light- handed period. Under the Airport Authorities Act 1966 (as amended in

1986) an airport company can set charges “as it ... thinks fit”, providing it has first consulted with its major customers (the airlines).

The issue before the Court of Appeal was whether Wellington airport’s pricing decisions could be judicially reviewed. Air New Zealand wished to challenge factors such as asset valuations, the WACC (weighted average cost of capital) and passenger growth assumptions. The Court struck out this claim on the basis that the Courts were not well suited to address such issues and that Parliament had decided that price control would be undertaken through Part 4 of the Commerce Act if at all.

D. Conclusion

As these three decisions illustrate, new entrants and customers have had little solace from the Courts in relation to pricing disputes or concerns about other terms of access. While some judges and commentators have expressed concern,¹³ it is hard to see how the high level principles of s

36 or prime necessities or judicial review could be used to determine complex issues of pricing or the terms on which an incumbent should deal with new entrants.

Determining the “right” price is always a convoluted and contested matter involving issues of appropriate valuation techniques, setting

¹¹ Above n 10, at 666.

^{12 Air New Zealand v Wellington International Airport ltd [2009] NZCA 259;}

^{[2009] NZCA 259; [2009] 3 NZLR 713.}

^{13 See, for example, Thomas J in Vector Ltd v Transpower New Zealand}

^{Ltd [1999] NZCA 167; [1999] 3 NZLR 646, Rex Ahdar “The unfulfilled promise of New}

^{Zealand’s monopolisation law: Sources, symptoms and solutions” (2009)}

^{16 Competition & Consumer Law Journal 291, Gault J in Telecom v Clear}

^{above n 8, and Baragwanath J in Air New Zealand v Wellington International}

^{Airport Ltd, ibid.}

the cost of capital, cost allocation methodologies, and so on. These matters require more detailed principles and procedural safeguards than provided by s 36 or judicial review, and they also need to be dealt with in an institutional setting with the appropriate economic and accounting resources.

At any rate, as we will now see, the rapid increase of economic regulation directed at parties with monopoly power (including the subjects of the three cases: Telecom, Transpower and the airports) means that the Courts’ role is now more likely to be in reviewing the regulator than in reviewing the party with market power.

3. The Re-regulation of utilities in New Zealand

A. Introduction

In contrast to the visibility of the 1984 reforms, re-regulation has been a much quieter revolution.

Exhibit 1: 1000 pages of material from the Commerce Commission, released in June 2009, explaining how the new price control framework in Part 4 of the Commerce Act (which I will discuss shortly) will apply to electricity lines companies, gas distributors and airports.¹⁴

How did we go from the view, as expressed by the Chair of the Commerce Commission in 1998, that “‘Light handed’ regulation provides an attractive, less economically distortionary alternative to heavier forms of regulation”¹⁵ to this new environment?

First, there was a growing mix of concerns in the 1990s that companies with market power were doing some or all of the following: not dealing fairly with new entrants; increasing prices excessively; shipping dividends to offshore owners; and failing to make expected investments in the New Zealand economy.

Second, the light-handed approach was starting to be regarded as a “no- handed” approach.¹⁶ That is, with the Commission, the Courts and the Government¹⁷ all stepping back from price control and interconnection issues, there was a sense that companies with market power had too much of a free reign. This all came to a head with the election of the Labour/Alliance Government in November 1999.¹⁸ Labour ’s pre-

14. <www.comcom.govt.nz/IndustryRegulation/InputMethodologies/ Overview.aspx>.

^{15 Above n 4.}

^{16 Ross Patterson “Utility Regulation in New Zealand: From Light-Handed}

^{to Many-Handed” (paper presented to ACCC Regulatory Conference, 30}

^{July 2004).}

^{17 The 1984–1990 Labour Government was succeeded by a National}

^{Government (1990–1997, led by Jim Bolger, then Jenny Shipley with Ruth}

^{Richardson then Bill Birch as the Ministers of Finance) with a similar}

^{laissez-faire leaning.}

^{18 Signs of change started to emerge in the late 1990s. In 1998 the Minister of}

^{Commerce requested the Commission to conduct a price control inquiry}

^{into Christchurch, Wellington and Auckland Airports. Then, frustrated by}

election policy statement had indicated that it supported “more specific intervention than the Commerce Act in its present form provides” in order to protect consumers in some industries.¹⁹

By February 2000, the Clark-led Labour/Alliance Government had announced Ministerial inquiries into telecommunications and electricity. As will soon be seen, both inquiries produced final reports within eight months that led to industry specific economic regulation. Once out of the bottle, the genie of regulation quickly spread to other industries.

Let us look at those changes and what has happened since.

B. Telecommunications

The Fletcher Inquiry (named after its chair, Hugh Fletcher) issued its report in September 2000 and recommended the introduction of a new sector specific regulatory model for resolving disputes between carriers. This was implemented by the Telecommunication Act 2001. Determinations of terms of interconnection (the subject matter of the Telecom v Clear litigation) and terms under which Telecom was required to wholesale most of its fixed line business and residential services soon followed.

There was also a Commission inquiry in 2003 in relation to unbundling (that is, whether Telecom should be required to allow competitors to install equipment in its exchanges and use its lines, so that the competitors can provide services to their customers). The decision was not to require unbundling at this stage.

Two Commission inquiries between 2004 and 2006 recommended that mobile termination rates (that is, how much Telecom and Vodafone pay the other when one of their customers calls a person on the other network) should be subject to price control, but were not adopted by the Government.²⁰ Again each inquiry, summarised here in a sentence, has involved thousands of pages of submissions and expert reports, and days of conference hearings.

After five busy years of reform, more was to come in 2006 when extensive amendments were made to the Telecommunications Act (you may recall the Cabinet paper leaked to Telecom). In particular:

• Unbundling was required; and

• Telecom was forced to separate its operations into retail, wholesale and network units in order to ensure non-discrimination in providing services to competitors.

increasing charges by lines companies, the Minister of Energy threatened to regulate unless charges were lowered (Hon Max Bradford, Media Release, 14 May 1999), and legislation to do this was in fact introduced into Parliament by the National Government on 1 June 1999 (Commerce (Controlled Goods or Services) Amendment Bill 1999).

^{19 NZ Labour Party “Improving Competition”, 10 April 1999, at 7.}

^{20 These recommendations were not accepted by the then Minister (Trevor}

^Mallard).

Finally, in June 2009, in a draft report, the Commission, for a third time, recommended cost-based price regulation of mobile termination rates.

C. Electricity

I described before that the deregulation of the electricity industry had resulted in contested wholesale and retail markets, with the natural monopolies owning the national grid (Transpower) and local distribution lines (29 lines companies with local monopolies). Re-regulation has focused on these monopoly elements of the industry.

The first step was the introduction of Part 4A of the Commerce Act in

^{2001 which contains a price control regime specific to Transpower and}

^{the lines companies. Part 4A was recommended by the Caygill Inquiry}

^{(named after its chair, David Caygill) Report in June 2000. The Report}

^{contained just eight paragraphs on the topic which is worth stressing}

^{since the electricity price control regime has become the baseline which}

^{has normalised similar interventions in other industries.}

Part 4A was implemented with the Commerce Commission setting “CPI-X” price paths in June 2003. What does that mean? Basically, if a lines company increased its prices by more than inflation minus X it risked a formal investigation. X factors were determined by the Commission specific to each lines company and ranged from +2 to -1 (+2 means that they can only increase prices by inflation minus two per cent, -1 means they can increase by inflation plus one per cent). The Commission has conducted a number of post-breach inquiries, which have resulted in “administrative settlements” with Unison (2007), Vector (2008) and Transpower (2008).

What next? After keeping the industry and its consultants busy for eight years, Part 4A was itself replaced from April 2009 with a new Part

^{4 of the Commerce Act. The new Part 4:}

• Contains a framework for price control, negotiate/arbitrate and information disclosure regulation for any industry;

^{• Has specific provisions dealing with electricity lines businesses,}

^{gas pipelines and airports;21 and}

• Started a process of determining “input methodologies” in relation to valuing assets, allocating common costs, determining WACC and the other “building block” components used to determine a “reasonable return”.

The “input methodology” process will last till at least the middle of

^{2010, plus appeals.}

But wait there’s more. First, in 2003 the Electricity Commission was formed to set and police trading rules for the wholesale market. The

²¹ In terms of other goods and services that may be candidates for economic regulation, the Commission may now carry out inquiries on its own initiative (or at the Minister ’s request), but the final decision to impose control still rests with the Minister.

Electricity Commission also approves Transpower’s pricing methodology. That is, the Electricity Commission now deals with the sort of issues that Transpower and Vector were fighting over in the 1990s. Not to be left out, the Commerce Commission has been investigating alleged Commerce Act breaches by the major generators and retailers. Its report, released in May 2009, essentially gave the industry a clean bill of health in terms of competition issues, but you may remember the “$4.3 billion price gouge” headlines from a report by Professor Frank Wolak.

Finally, a Ministerial Review is currently looking at what further changes would be desirable.²²

D. Other sectors

In order to appreciate the full extent of re-regulation it is necessary to mention a number of other sectors of the economy. In summary:

1. Airports

As I discussed in relation to the Air New Zealand litigation, an airport company has a statutory power to set charges “as it ... thinks fit”. In terms of re-regulation:

• In 1998, the Minister of Commerce requested the Commission to carry out a price control investigation in relation to Christchurch, Wellington and Auckland airports;

• The Commission’s report (2002) recommended control of pricing at Auckland airport, but the Minister declined to impose control given the modest benefits and significant costs of regulation; and

• Airports now come under the information disclosure regime in the new Part 4.

2. Dairy

When Parliament passed the Dairy Industry Restructuring Act 2001 to allow the two largest dairy companies to merge (together with the Dairy Board) to form Fonterra, various regulatory safeguards were created to allow for the entry and exit of shareholding farmers and for the supply of raw milk to independent processors. The Commission is responsible for administering these provisions and determining any disputes that arise. A review of the regulated raw milk regime was completed by the Ministry of Agriculture and Forestry in April 2008.

3. Banking

In terms of the economic regulation of banks (in addition to the prudential supervision conducted by the Reserve Bank of New Zealand) note that:

²² Postscript: The Ministerial Review resulted in the Electricity Industry Bill having its first reading in December 2009. It promises further major reforms to both the governance and operation of the sector.

• State-owned Kiwibank was created in 2002 to address a concern about insufficient competition and the lack of a New Zealand owned competitor; and

• The Credit Contracts and Consumer Finance Act 2003 came in force in April 2005 which, amongst other things, requires fees in credit contracts to be “reasonable” having regard to “costs” and “commercial practice”. The Commission again has the primary enforcement role.

4. Rail

As a result of de-regulation (for most of the twentieth century there were limits on haulage by road to protect rail) and privatisation (1993), the main rail company in New Zealand (TranzRail then Toll) owned and operated the railways in New Zealand. In terms of re-regulation, following concerns about inadequate investment in rail and its financial viability, the Crown bought back the “below rail” infrastructure in 2004 and then the above rail assets in 2008 to form KiwiRail.

5. Gas

Finally, gas. The Commission had a legacy role in determining the charges that gas utilities could charge which was removed with the passing of the Gas Act 1992. This was the last activity to be removed from direct price controls as part of the 1984 reforms. Information disclosure obligations were introduced in 1997.²³ In terms of re-regulation:

• A price control inquiry was completed in 2004 and control was imposed on various gas pipeline businesses between 2005-2008,²⁴ and now comes under the new Part 4.

• Separately from these price control issues, in 2004 the Gas Industry Company was established under the Gas Act as an industry- owned co-regulatory body able to make recommendations to the Minister of Energy on issues such as the wholesaling, processing, transmission, distribution and retailing of gas.

6. Conclusion

The 1999 revolution has been as dramatic as the 1984 revolution, but with much less visibility and little commentary outside of “competition and regulation conferences”, or as they now tend to be called “regulation and competition” conferences.

In 1984 the starting point for regulating utility companies was a light- handed approach. It is perhaps not surprising that the complex issues

²³ Gas (Information Disclosure) Regulations 1997.

^{24 See Commerce (Control of Natural Gas Services) Order 2005; Commerce (Control}

^{of Natural Gas Services) Amendment Order 2005; Commerce Commission,}

^{Decision 656 (Powerco) and Decision 657 (Vector), 30 October 2008; and}

^{Commerce Commission, Authorisation for the Control of Supply of Natural}

^{Gas Distribution Services by Powerco Ltd and Vector Ltd, Decisions Paper, 30}

^{October 2008.}

of pricing and interconnection have required more proscriptive regimes. However, the cumulative effect of all the reforms I have touched on has been a sea change move towards price control regulation and similarly invasive controls. This re-regulation has been conducted at a rapid pace, and with limited analysis.

I now move to discuss what lessons we can learn from all of this.

4. Lessons from 25 years of regulatory reform

A. Why it is important

The importance of getting the regulatory frameworks right in these sectors cannot be understated. The kinds of businesses and industries we are talking about involve billions of dollars of annual expenditure and revenues, and hundreds of billions of dollars worth of assets. These industries provide services that the rest of the economy depends on and that are, or are close to, “necessities of life”.

While “high” prices are bad for consumers in the short run, in the long run “low” prices may result in insufficient investment. In the telecommunications industry, underinvestment may mean that new technologies are slower to be made available. In the electricity industry, underinvestment may mean blackouts.

B. Overall assessment

Despite the importance of getting the balance between State and market right, the reform processes discussed in this paper have tended to be political, reactive and ad hoc:

• The reforms have been political in the sense that they have tended to be driven by changes in Government: for example the sea changes that occurred in 1984 and 1999. Different political philosophies (Think Big versus Rogernomics versus The Third Way) appear to have been more influential than empirical analysis.

• The reforms have also tended to be reactive rather than pro-active.

^{That is, like a pendulum we saw an extreme form of light-handed}

^{regulation introduced in response to the regulatory excesses of the}

^{Muldoon era. The resulting access disputes and concerns about}

^{“excessive” pricing have led to the rapid re-regulation I have just}

^described.

• And they have tended to be ad hoc. That is, Ministerial inquiries and working parties have been set up to review these issues on a case-by-case basis.

It is important to do better if we can, and I think we can. Let me propose two candidates for reform:

1. We should have a Regulatory Reform Commission

I support the formation of a permanent body, independent of business and independent of government, that is focussed on market design,

^{regulatory design and other similar microeconomic issues.}

The closest model for such a “Regulatory Reform Commission” is perhaps the Productivity Commission in Australia. The concept of a Productivity Commission for New Zealand is under active consideration by the Government as a result of the National-ACT Confidence and Supply Agreement.

The kinds of issues that a Regulatory Reform Commission would address in our present environment could include:²⁵

(a) Should competition enforcement and economic regulation be conducted by the same body?

Most of the responsibility for administering the new regulatory environment has fallen on the Commerce Commission. Largely as a result of this, its annual expenditure has grown from $7m in 1999 to

^{$43m in 2009. (If its expenditure had increased by just the inflation rate}

^{over this period it would have reached only $9m.)}

There has been public criticism of the current round of reforms and the performance of the Commission. Without entering this debate, there are institutional design issues to consider about whether our competition law enforcement agency should also be our chief economic regulator.

Economic regulation should be about clear rules for the future to provide certainty and encourage investment, whereas competition law is about detecting and punishing “bad behaviour”. These roles require different skills and result in quite different relationships between the regulator and the companies they regulate.

Either clearly separating these functions within the Commission or creating separate regulatory and competition authorities should be considered.

(b) How do we check that reforms turned out the way they were supposed to?

This is probably the most important question to ask. There seems to be little analysis of what has and has not worked well. The imposition of regulation is typically proceeded by debates about the best form of regulation, the likely direct costs, the likely effects on investment and the likely benefits. However, little or no “after the fact” analysis occurs to see if the promised benefits of reforms eventuated and if the estimated costs were correct.

Choosing the right regulatory rules involves lots of difficult theoretical and empirical questions. Learning from past interventions is the best way to improve regulation. A Regulatory Reform Commission could monitor, review and evaluate the body of economic regulation in an ongoing and systematic way.

²⁵ A Regulatory Responsibility Taskforce is currently considering some of these issues in the context of the Regulatory Responsibility Bill that was considered by the Parliament’s Commerce Select Committee in 2008.

^{(c) How do we make regulatory decisions reversible?}

We should also ask, “How do we implement regulation in a way that makes it easiest to remove at a later date?” For example, the Telecommunications Act has created a “resale” regime (ie it is required to wholesale its fixed line services to other carriers) which will politically be hard to end even if the concerns that led to it no longer exist because new reseller businesses depend on it.

(d) How can we reduce the fixed costs of regulation?

Our current approach to price control creates a large overhead for a small country. As mentioned above, the Commission’s expenditure has increased from $7m in 1999 to $43m in 2009. Furthermore, each report, process, determination and inquiry I have mentioned will typically have involved a mountain of paper and a significant consultation process. Take the 1000 page discussion paper on the new Part 4. If 20 companies have 5 people reading it at 25 pages per hour and at $200 per hour, that represents a $800k regulatory burden just to read it, let alone make submissions on it! We should consider what we can borrow from overseas and what we can do smarter.

(e) What should the priorities be for the country?

A related question is what should our regulatory priorities be? Could the time and effort currently spent on the telecommunications and electricity sectors be better spent elsewhere? Would New Zealand Inc be better off if the same attention was given to health sector reform for example? A Regulatory Reform Commission would be able to take a broader perspective as it would be free from the day to day work programme of regulatory economics.

I do not pretend to have easy answers to any of these questions, but it seems eminently sensible that a body of equal stature to the Commerce Commission should be considering them, and in a proactive rather than reactive manner. A Regulatory Reform Commission would allow these issues, which are vital to the country, to be considered proactively and in a non-partisan way, and by a body which would develop a permanent core of expertise.

2. We should have genuine merits review for all decisions to the Courts

Secondly, I support much broader rights of appeal from regulatory decisions, particularly decisions of the Commerce Commission.

The current rights to challenge Commission decisions follow no particular rhyme or reason. Parties may appeal from certain decisions on questions of law only, other decisions are not subject to appeal rights but are judicially reviewable (that is, for process errors, error of law, or Wednesbury unreasonableness) and decisions in relation to authorisations or clearances of mergers are subject to appeals by way of re-hearing.

It is only the latter category that amounts to merits review. That is, the Court is able to substitute its decision for that of the Commission. Otherwise Courts are limited to supervising process, and making sure

the statute has been properly interpreted. In my view merits review should be the norm, not the exception for four reasons.

First, the Commission is fallible. Given that its decisions affect property rights, business values and the performance of the economy, there should be an error correction mechanism. The risk of an appeal helps to ensure the right answer in the particular case and quality decision- making overall.

Second, a body of Court decisions will help create “regulatory principles” to guide the Commission and participants in future proceedings. This is important as it enhances certainty. This has happened in relation to mergers and acquisitions which are currently subject to merits review.

Third, without merits review, participants who are unhappy with a Commission decision will try and shoehorn their grievance into an appeal on a question of law or a judicial review claim. This is ultimately unsatisfactory for the Commission, the claimant and the Courts.

And finally, it is important that a body such as the Commission be accountable. It has extensive powers of economic regulation and wide ranging information gathering powers, and it should be subject to checks and balances. Parties should be able to have their “day in Court”– an outcome they are much more likely to be able to live with than to be left with the feeling that they never stood a chance in a Commission process. Merits review has been proposed in the past,²⁶ and the growth of regulation in recent years makes it even more compelling now.

The input methodologies currently being established under the new Part 4 will be subject to a “merits review” of sorts.²⁷ However, this may well turn out to be a misnomer since (a) no new evidence can be put before the Court (so the Commission will have a “last mover” advantage as the decision-maker) and (b) the only ground of challenge is that a different approach would be “materially better” at meeting the purpose statement. This is a new process, but the evidence and arguments will be constricted, and instead of the Court asking what is the right answer, the debate will be about what “materially better” means, and how you apply the test when the purpose statement has many dimensions.

The usual reasons against merits review are cost, delay and institutional competence. However, these concerns can be managed for regulatory decisions as they are currently managed for merger clearances and authorisations. That is, appeals should be by way of “re-hearing” of the

²⁶ David Goddard “Regulatory Error: Review and Appeal Rights” (paper presented to Legal Research Foundation. Conference, Auckland, September 2006); Victoria Heine “Reviewing the merit of merits reviews: does New Zealand need them?” (7th Annual Competition Law and Regulation Review, 26 and 27 February 2007); and Neil Quigley “Institutional Arrangements for Welfare-Enhancing Anti-trust and Price Regulation” (paper presented to ISCR conference, June 2007).

^{27 Sections 52Z and 52ZA.}

evidence that was before the decision-maker, and new evidence should only be admitted with the leave of the Court.²⁸

To deal with the complex subject matter, we should also consider establishing a special independent judicial body at the level of the High Court, with a mix of High Court judges and expert economists/ accountants as its members. This is similar to the current system of lay members (ie expert economists who sit with Judges on competition cases), but allows for more specialisation particularly by the Judges. Analogies exist in the form of Competition Appeals Tribunals in Australia and England.

I do not have time this evening to fully explore the idea of a specialist tribunal, so, let me conclude this lecture simply by suggesting that it should be one of the first jobs for our new Regulatory Reform Commission. Ladies and Gentlemen, let me draw things to a close here.

Postscript (15 June 2010): A number of important developments have occurred since this lecture was given. First, in late 2009 the Government announced various changes to the electricity sector which are currently before Parliament in the form of the Electricity Industry Bill. Secondly, in March 2010 the Government announced that a New Zealand Productivity Commission would be established in early 2011.

²⁸ See Commerce Commission v Woolworths Ltd [2008] NZCA 276.