Friday, 20 December 2013

Compensating investors for regulation

Bryce Wilkinson has an NBR article that expands on his recent NZ Initiative email about telco regulation. He argues that NZ started down a slippery slope by regulating telecommunications in 2001, against the advice of "critical economists", that the Chorus mess is a consequence of doing so, and that its a long hard road back to "respect for private property rights and the rule of law".

He points to productivity growth in a group of industries that includes telecommunications, which was 2.9% p.a. from 1987-2001 under "light-handed regulation", but fell to 1.7% p.a. from 2001-11. The reader is invited to conclude that regulation caused this productivity slump. It didn't.

Here are the relevant data as reported by StatsNZ.
The ICT, media and telecom sector (the one Bryce cites) has always had higher productivity growth than either the goods producing sector or the service sector as a whole, both before and after 2001. I can't see how you could reasonably blame telco regulation for a general productivity slow-down.

There has of course been a monumental stuff-up over UFB, but its a bit rich to blame that on regulation when well informed adults signed up to those contracts voluntarily, knowing full well how the regulation would work.

Bryce's main theme though is a broader assault on regulation, because it is disrespectful of property rights. He recognises that Parliament has the ability to regulate but says
...in a civil society, respect for private property rights should provide some protection against the politically expedient use of the Crown’s coercive powers. First, the Crown would have to demonstrate that a taking of rights in private property was justified in the public interest; second, it would have to consider the issue of compensation.
I agree 100%. Where we disagree is on applying these principles. For example, Bryce thinks NZ shouldn't have regulated Telecom's market power in 2001, because that market power was acting as an incentive for competing investors rather than a deterrent. This paper from 1998 (pdf) is a good example of his thinking at that time - the executive summary alone is worth a read.

Bryce argued that Telecom should be fully compensated for the entire stream of future profits that were being lost. This same argument was run in the context of unbundling in 2006.

Lets just follow that logic for a minute. If you somehow end up with an unregulated investor-owned natural monopoly, then regulating it is definitely a "taking of rights in private property". Bryce says it might be OK for a country to do that, but only if investors are fully compensated for their loss.

In the 1990s, investors in electricity distribution networks enjoyed a dream run. They racked up hundreds of millions of dollars a year by simply writing up the value of their assets, and then increasing their prices to "compensate" for all that extra "capital". This wasn't illegal - far from it. It was in fact a direct consequence of the "light-handed regulation" that Bryce advocates, which also conferred on those investors a property right to keep doing it. By his logic, when this game was finally stopped we should have paid out those investors for all the future write-ups that were being taken from them.

I think there is a counter-argument that Kiwis had a right to not be charged excessive prices for basic services, and that those rights were breached by this ridiculous form of "regulation". This approach is tricky though. For example it leads to questions about which of the previous status-quo positions should be selected as the dawn of time, from which point compensation should be calculated. There is also a practical problem of the leaky-buildings type because many of the perpetrators have moved on, closed down their legal entities, etc.

To summarise, I am a firm believer that compensation should be paid for unjust takings, that we should assure investors this will occur, and stick to those assurances. Nevertheless, there certainly are cases when it is entirely just to dispossess investors without compensation, and to ignore the inevitable outrage. The revaluation rort is a good local example and I'd put this classic in the same category.

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