Credible Threats as an Instrument of Regulation for Network Industries

REGULATORY CHANGES, INNOVATIONS AND INVESTMENT DYNAMICS IN THE DIGITAL WORLD ECONOMY, P. Welfens, ed., pp. 171-202, Berlin, 2006

Posted: 21 Mar 2006 Last revised: 15 Jul 2010

See all articles by Justus Haucap

Justus Haucap

Heinrich Heine University Dusseldorf - Department of Economics; German Institute for Economic Research (DIW Berlin)

Ulrich Heimeshoff

Ruhr University of Bochum - Faculty of Economics

André Uhde

University of Paderborn - Faculty of Business Administration and Economics - Department of Taxation, Accounting & Finance

Date Written: August 1, 2005

Abstract

In order to avoid over-regulation, some countries have experimented with what might be called threat-based regulation. The idea is - similarly to the contestable market model - that actual regulation may not be necessary as long as the threat of regulation is credible. In that case, so the idea, even monopolies will abstain from setting monopolistic prices in order to avoid being regulated. As experience from Germany and New Zealand has demonstrated, there are quite a number of problems associated with threat-based regulatory systems. The most significant problem has turned out to be the likely under-regulation and according welfare losses from market power, and in this context, a critical issue that has been identified is the credibility of the regulatory threat. If the threat of regulation is not credible, a light-handed regulatory regime (LHRR) amounts to leaving monopolistic firms unregulated, clearly an undesirable situation from a welfare point of view. This failure of threat-based regulatory systems results from potential free-rider problems associated with good corporate behaviour (as in the case of Germany's electricity market) as well as the lack of credibility of the threat either because of the weakness of the enforcement authorities or due to political constraints. Furthermore, a problem emerges if exercising the threat of regulation implies an abandonment of the LHRR and a corresponding substitution with heavy-handed ex ante regulation. An innovative way out of this dilemma has been the quasi-automatic threshold system originally designed for New Zealand's electricity distribution networks, which aims at simulating the pressures that companies would face in competitive markets.

Keywords: light-handed regulation, network industries, electricity, telecommunications

JEL Classification: L96, L94, L50, K23

Suggested Citation

Haucap, Justus and Heimeshoff, Ulrich and Uhde, André, Credible Threats as an Instrument of Regulation for Network Industries (August 1, 2005). REGULATORY CHANGES, INNOVATIONS AND INVESTMENT DYNAMICS IN THE DIGITAL WORLD ECONOMY, P. Welfens, ed., pp. 171-202, Berlin, 2006. Available at SSRN: https://ssrn.com/abstract=890107

Justus Haucap (Contact Author)

Heinrich Heine University Dusseldorf - Department of Economics ( email )

Duesseldorf
Germany

HOME PAGE: http://www.dice.uni-duesseldorf.de

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Ulrich Heimeshoff

Ruhr University of Bochum - Faculty of Economics ( email )

Ruhr University of Bochum
Faculty of Economics
D-44780 Bochum, DE 44780
Germany

André Uhde

University of Paderborn - Faculty of Business Administration and Economics - Department of Taxation, Accounting & Finance ( email )

Warburger Str. 100
D-33098 Paderborn
Germany

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