It is not a piece of cake when talking about regulating monopolists
It came to my surprise when I read from the media that Macau had been relying on China in supplying around 90% of its electricity since 1984. I doubt the need for doing so when then Macau had already had its own electricity company, such that expanding supply should not be difficult. I tried to search for the rationale for doing so but in vain.
Hong Kong government had previously raised the possibility to import electricity from China. In 2014, the government published Future Fuel Mix for Electricity Generation consultation paper stating that:
3.16 Electricity imports and exports have been practised in many other countries, such as the US, the United Kingdom, and within the European Union (EU). Within a country, it involves the transfer of electricity from one region where generation is based to consumers in other regions. Electricity import also takes place between countries as in the cases of Switzerland and Germany importing electricity from France. In the case of the Macao Special Administrative Region, it imports about 90% of its electricity from the Mainland power grid.
3.17 In the case of Hong Kong, if we are to import electricity from the Mainland, this may be done through importing electricity directly from the China Southern Power Grid Co. Limited (CSG), which is already connected to CLP’s power grid.
The Environment Bureau even made importing more electricity through purchase from China one of the two options for dealing with future electricity needs, but such suggestion was opposed rigorously by most respondents.
In any case, the electricity outage as a result of the Typhoon Hato makes Hongkoners more sceptical in any proposals making Hong Kong more reliant on China, and the two local electricity companies now have stronger bargaining power in negotiating with the government in increasing its capital investment and therefore their profits.
The “Original Sin” of Monopolists
Monopolists are usually seen as greedy and earning excessive profits, but this is not necessary the case if this is viewed from an academic perspective.
It is unavoidable for monopolists to exist in society. When an industry has high fixed cost, high entry barrier, and with network effects, it is easiler for the incumbents to become the only firm in the industry. Taking electricity market as an example. Building power stations is expensive, and more for laying out the grid to every single household in the territory. Notwithstanding the huge initial investment, the marginal cost and average cost for actual supply of electricity would decrease with output level. Even if a monopolist does not engage any anti-competitive practices, it is very difficult for new comers to compete. In Hong Kong, contrary to many’s impression, the two electricity companies are not granted with exclusive franchise in supplying electricity, but still no new entrant has been seen, apparently due to economic considerations.
Economists usually say that monopoly is a bad thing. This is a statement against the context of the efficient operation of a perfectly competitive market. The fact is that, economically, firms, no matter they are in perfectly competitive market or they are the monopolists, make their production decision based on the same principle: they maximize their profits by increasing production until the point when the marginal revenue equals to their respective marginal cost. You may ask the reason for them to just stop there but not produce more. The answer is that, production beyond that point would result in less profit, and it is natural for a reasonable person to maximise its profit.
In a perfectly competitive market, none of the market players has any power to influence the market price, and as a result, they need to reduce the cost in order to maximize their profit. However, for necessities such as electricity, demand remains more or less the same no matter how high the price the monopolist sets — a situation economists call low demand elasticity. When monopolists could affect the market price by restricting output, they have no incentive to reduce cost, as such cost would ultimately transferred and bore by consumers. This is why when comparing with perfectly competitive market, monopolist markets have lower production levels and higher prices. Economists consider that monopoly market is not efficient. On the other hand, monopolists are considered to earn excessive profits, despite that they make their decision the same as everyone does.
Difficulties in Regulating Monopolists
There are several possible ways to deal with the problems brought by a monopoly market, but none of them is perfect. One of them is introducing new entrants such that they can compete. But this could only be used in some industries. For instance, in the telecommunications market, which was usually a nationalised service, the market has been expanding such that it is possible to accommodate more firms who compete with each other. On the other hand, having only one firm in the market does not necessarily mean that it has unconstrained power. In Hong Kong, MTR is the sole train operator but still citizens can choose from other public and private transportation means which exert competitive constraint on MTR. When West Rail commenced its services about a decade ago, many residents still largely relied on bus due to the comparatively higher service price. MTR later introduced monthly tickets for frequent commuters in order to compete with its rival. However, it is more difficult for the case of electricity supply, though not impossible. For instance, the two electricity companies may have their grids connected such that users may choose from the two. But it appears that some other considerations in the government’s mind prevail over enhancing market competition. If bringing in new competition is not possible, the only way out would be regulation.
The economic goal for regulating monopolists is to ensure that it would not charge excessively. Price-cap regulation is the “simplest” way such that the price of the product is set at the level that a perfectly competitive market would do. This could give incentive to monopolists to reduce its cost to earn profit and at the same time protect consumers’ interests. However, implementing price-cap regulation in reality is not that easy, as regulators in fact do not know the actual cost of monopolists. It is possible for the regulators to set the price too high rendering the regulation meaningless, or set it too low making monopolists lossing money. This is the problem raised by asymmetric information of the monopolists’ cost between the firm and the regulator.
Another way is to cap the rate of return of monopolists to prevent them from earning “excessive profits”. However, this kind of regulation gives no incentive to monopolists to reduce its cost and become more efficient, since the efforts spent on reducing cost would not increase its profit. As a result, users are still paying prices higher than that in perfectly competitive market. This is why our local electricity companies are so eager in building new generators, despite criticisms that some of the existing are in fact redundant.
No matter which of the above regulatory schemes is used, it is unavoidable for monopolists to be required to submit tons of accounting and financial information, such that the regulator could find out the proper prices or profit caps. I personally consider this is not that meaningful as even the information reflects the actual financial situation of the monopolists, accounting cost/profit, etc. are different from economic cost/profit and the r resulting caps may not be able to address the problems, let alone this kind of information usually contain creative elements. In any case, the cost spent by both the monopolists and the regulators in this would ultimately be paid by users, deapite that the decisions are unavoidably made more or less politically.
Still, another way to deal with monopolists is to nationalise the business such as water supply in Hong Kong. This is the favourite solution of leftists, who consistently asking the government to buy back MTR and the Links. But does it really a better option? Not necessary. The low price of water supply in Hong Kong is due to government subsidy. In financial year 2017/18, Water Supplies’ estimated expenditure is HK$ 8.2 billion, with HK$ 4.7 billion used for buying water from China. Despite the cost, we are still drinking contaiminated water, and has no ways to ask government not to buy excessive water from China.
While it is easy for politicians to ask for regulation of monopolist, do they really understand whether regulation really does the trick?
