Tuesday, 9 September 2014

A "pretense of knowledge" problem?

Over at the, ever interesting, Economics New Zealand blog Donal Curtin writes,
Chorus got bowled like ninepins this morning by the Court of Appeal, having earlier been skittled by the High Court.

The cases were about the Commerce Commission proposing a big reduction in the price Chorus could charge for UBA, or as it is formally defined, "the additional UBA service component, which allowed access seekers to supply broadband services over Telecom’s copper access lines without investing in their own equipment or software". In other words, the bits and bobs that carry broadband traffic across the gap between the copper line from your place and the start of an ISP's network.

The reduction (roughly halving the price) had been based on a benchmarking exercise, where the Commission (as required by the Telecommunications Act) looked at the prices overseas for UBA as a quick and dirty proxy for what it might well cost here. There's lots more about the exact details of the benchmarking comparability exercise, but that's the gist of it.
So now on we go to the Commission's final word on the UBA price, which will be determined by modelling the actual costs of an efficient provider in New Zealand (Chorus had exercised its right to object to the benchmark stab at the price and to have local costs estimated explicitly).
So what's my problem here? In short, it isn't the job of courts or regulators to determine costs or prices. About the only thing you can say about outcomes determined by such procedures is that they are wrong. As I noted in a post a couple of days ago, Dixit on costs, Avinash Dixit writes that,
In other words, opportunity costs are the correct measure. But these are based on expectations and calculations done within firms, and are not available in reported data.
If we accept this, then its not clear what basis the regulator or the courts have for determining costs and thus prices. At best these bodies have to deal with "reported data" but as noted such data misses some of the most important determines of opportunity costs. Without measures of theses how can a regulator or court arrive at any sensible view on what costs are?

Looks like there is a bit of the "pretense of knowledge" problem here.

1 comment:

Donal Curtin said...

Thanks for the coverage and comments, and I mostly agree. However, unfortunately but unavoidably, it is the job of regulators to set some prices in situations where important markets aren't functioning competitively. I'd prefer if it wasn't, and personally I'd fire the price regulation gun only as a last resort if all other more market-friendly options were exhausted. But that said, even generally pro-market governments find themselves setting some prices. I agree that the process is imperfect, and there are multiple methodology and other choices to make along the way each of which introduces room for error. But sometimes it has to be done, and as well as you can manage, and preferably (as ComCom tends to do) with investment-friendly "err on the high side" numbers, to keep investment flowing into the regulated sector. The opportunity cost point is fine, but I wonder if in practice it's addressed (albeit in some rough and ready fashion) when regulators set a rate of return equal to that earned by "similar" sorts of activity, given that they're likely to be the sorts of activities the regulated company would otherwise have pursued?