Costs of regulation

There is a new NBER working paper out on Measuring the Cost of Regulation: A Text-Based Approach by Charles W. Calomiris, Harry Mamaysky and Ruoke Yang.

The abstract reads,

We derive a measure of firm-level regulatory costs from the text of corporate earnings calls. We then use this measure to study the effect of regulation on companies’ operating fundamentals and cost of capital. We find that higher regulatory cost results in slower sales growth, an effect which is mitigated for large firms. Furthermore, we find a one-standard deviation increase in our preferred measure of regulatory cost is associated with an increase in firms’ cost of capital of close to 3% per year. These findings suggest that regulatory risk is a major cost to firms, but the largest firms are able to manage that risk better.

One obvious point here is that regulation is costly to firms. But it is less costly to large firms than small, this has implications for competition policy. Large firms may support regulation as a way of increasing the costs of small firms relatively more than for large firms. This means that large firms can use regulation as a way of forcing new, innovative small firms out of the market, and thus reduce competition.

When usury laws are counterproductive

Is it a good idea have a ceiling on the interest rate, be that zero or some positive rate.

We study the effects of interest rate ceilings on the market for automobile loans. We find that loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. Usury limits may harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.

This is the abstract of a new working paper, Loan Contracting in the Presence of Usury Limits: Evidence from Automobile Lending (Consumer Financial Protection Bureau Office of Research Working Paper No. 2017-02) by Brian Melzer and Aaron Schroeder.

Melzer and Schroeder explain,

Usury restrictions are often motivated by the argument that lenders, if unchecked, will exercise market power and raise interest rates on risky borrowers beyond the level required to compensate for credit losses, origination costs, and required capital returns. Supporters of usury limits thus argue that lenders will respond to interest rate caps by extending credit at lower prices. Opponents counter that price ceilings will cause credit rationing, which reduces access to credit and harms precisely the risky borrowers that supporters of usury limits intend to help. We propose and investigate an alternative view that applies to the large market for certain subprime automobile loans: vehicle sellers can creatively contract around binding usury limits by financing their customers’ purchases and pricing default risk through the mark-up on the vehicle sale rather than through the interest rate.

The strategy of automobile dealers is simple. Vehicle loans are structured as installment contracts that require constant monthly payments for a fixed maturity (typically 3-6 years) and allow the lender to repossess the vehicle if the borrower defaults. Holding fixed the collateral, loan maturity, and principal amount, a lender is typically constrained to adjust the price of credit by changing the interest rate specified in the contract. For a lender that also serves as the vehicle seller, however, there is an additional degree of freedom—marking up the sales price of the vehicle. When the usury limit binds, the integrated dealer-lender can subsidize a negative net present value loan with a higher-margin sale. Within the loan contract, this change amounts to increasing the stated loan amount (along with the sales price) rather than the interest rate, thereby achieving the desired monthly loan payment while still complying with usury law. To give an example, a $9,000 loan at 30% interest has the same required monthly payment as a $10,650 loan at 20% interest over a four-year, fully amortizing term.

While dealers’ contracting flexibility allows them to approximate an unconstrained loan, it does not completely eliminate the friction introduced by the usury limit. First, the constrained and unconstrained contracts are not identical. When a dealer raises the stated loan amount instead of the interest rate, the borrower’s loan balance starts higher and remains higher until the end of the contract. Borrowers who prepay or default thus owe more to the lender when they terminate the contract. Second, risky borrowers may pay higher prices for credit, as their purchases depend upon financing from automobile sellers rather than a broader, and potentially more competitive, universe of third-party lenders. In an equilibrium with usury limits and dealer financing, therefore, few borrowers are completely excluded from the market, but dealers provide captive financing for a larger share of purchases and borrowers that receive dealer financing face different loan terms—lower interest rates, larger loan-to-value ratios, and possibly higher loan payments—than they would in the absence of usury limits (pp. 2-3).

Julian Simon's "Almost Practical Solution to Airline Overbooking"

The problem of airline overbooking has made headline over the last week. An obvious question this gives rise to is, how do we deal with the problem?

Timothy Taylor at the Conversable Economist blog gives us this explanation of economist Julian Simon's method for dealing with the problem of overbooking. Simon wrote a short note, "An Almost Practical Solution to Airline Overbooking" (pdf), in the May 1968 issue of the Journal of Transport Economics and Policy.

Here's how Simon described the idea in 1968:

Perhaps the reader has suffered a fit of impotent rage at being told that he could not board an aeroplane for which he held a valid ticket. The explanation is clear, and no angry letter to the president of the airline will rectify the mistake, for mistake it was not. The airline gambles on a certain number of cancellations, and therefore sometimes sells more tickets than there are seats. Naturally there are sometimes more seat claimants than seats.

The solution is simple. All that need happen when there is overbooking is that an airline agent distributes among the ticket-holders an envelope and a bid form, instructing each person to write down the lowest sum of money he is willing to accept in return for waiting for the next flight. The lowest bidder is paid in cash and given a ticket for the next flight. All other passengers board the plane and complete the flight to their destination.

All parties benefit, and no party loses. All passengers either complete their flight or are recompensed by a sum which they value more than the immediate completion of the flight. And the airlines could also gain, because they would be able to overbook to a higher degree than at present, and hence fly their planes closer to seat capacity. ...

But of course this scheme will not be taken up by the airlines. Why? Their first response will probably be "The administrative difficulties would be too great". The reader may judge this for himself. Next they will suggest that the scheme will not increase net revenue. But the a priori arguments to the contrary make the scheme worth a trial, and the trial would cost practically nothing and would require no commitment.

What are the real reasons why this scheme will not be adopted? Probably that "It just isn't done", because such an auction does not seem decorous; it smacks of the pushcart rather than the one price store; it is "embarrassing" and "crass", i.e., frankly commercial, like "being in trade" in Victorian England.

It does seem better than beating people up and dragging them off planes.

When business loves regulation

From NPR's Plant Money comes this audio on

A few years ago, Jestina Clayton started a hair braiding business in her home in Centerville, Utah. The business let her stay home with her kids, and in good months, she made enough to pay for groceries. She even put an ad on a local website. Then one day she got an email from a stranger who had seen the ad.

"It is illegal in the state of Utah to do any form of extensions without a valid cosmetology license," the email read. "Please delete your ad, or you will be reported."

To get a license, Jestina would have to spend more than a year in cosmetology school. Tuition would cost $16,000 dollars or more.

On today's show: Why it was illegal to braid hair without a license in Utah. And why hundreds of licensing rules in states all around the country are a disaster for the U.S. economy.

The good news in this story comes in the update at the end.

Imperfect electricity markets versus imperfect regulation

In reality neither markets or regulation work perfectly. So the question in practice is, which of imperfect markets or imperfect regulation works better. This issue is looked at in the April 2017 issue (pdf) of the NBER Digest.

In short

Market mechanisms led to increased coordination across utilities and less output from high-cost generators, substantially reducing the cost of producing electricity.

Linda Gorman writes in the Digest about research from Steve Cicala discussed in his NBER working paper "Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation".

Gorman writes,

In the last two decades, more than half of the wholesale electricity transmission systems in the United States have adopted some form of market mechanism to determine which power plants would operate. Based on an examination of hourly supply and demand patterns on the U.S. electrical grid, Steve Cicala estimates that these new markets reduced aggregate electricity generation costs by $3 billion a year. His results are reported in Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation (NBER Working Paper No. 23053).

Electricity production must be exactly synchronized with demand, which has large daily, weekly, and seasonal swings. The integrity of the U.S. electrical grid is maintained by roughly 100 "balancing authorities," which determine when power plants start up and shut down to match these fluctuations. Historically, these decisions were made by engineers within the vertically integrated utilities that owned the power plants, transmission system, and distribution networks that serve customers. This regulatory structure resulted in a grid built for reliability, rather than substantial interregional transmission of electricity. Over 90 percent of power was generated in the local power control area where it was consumed.

With changes in federal regulations (and encouragement from the Federal Energy Regulatory Commission), balancing authorities began to turn their responsibilities over to independent system operators, who use day-ahead and real-time auctions to balance supply and demand, often across multiple power control areas that were previously operating autonomously. Between 1996 and 2012, 60 former power control areas adopted such "market dispatch" overnight by either joining an existing market, or participating in the creation of a new one. Roughly two-thirds of electricity production in the United States is now determined by the outcomes of these markets.

Using data on fuel costs, capacities, heat efficiency, and the operations of nearly all generating units in the U.S., Cicala constructs power supply curves ranking production units from lowest to highest cost for each of the 98 areas at an hourly resolution from 1999 to 2012. He then estimates the excess costs that occur when higher cost plants are used to produce power even though lower cost plants are available. In some cases, using high cost plants is appropriate when lower cost generators are unavailable as a result of normal grid operations such as maintenance, refueling, start-up costs, and transmission congestion. Withholding lower-cost units from auction is also how firms exert market power. He also measures changes in trade across power control areas, and the associated gains from offsetting higher-cost generation.

He uses the staggered roll-out of markets to estimate the impact these new mechanisms have on production costs by comparing changes in operations following market adoption to those of areas that have not undergone any changes. Because fuel price changes unrelated to market transitions impact the measurement of cost savings, he uses machine learning algorithms to predict the system operator's complex rules for dispatching generators in the absence of markets, and compares observed and predicted behavior across groups. He finds that markets encouraged both increased trade across areas, and reduced usage of higher cost units. The 20 percent improvement in each of these metrics reduced production costs by about $3 billion per year.

Analysing the extent and effects of occupational regulation in New Zealand

A new paper, by Simon James Greenwood and Andrea Kutinova Menclova, has been published online for New Zealand Economic Papers on the above topic.

The abstract reads,

This study is the first to our knowledge to document the extent and correlates of occupational regulation in New Zealand. Using data from the Census and the Survey of Working Life, we estimate that 28% of workers’ primary jobs are affected by occupational regulation. This is lower than the 35% reported for the US but identical to UK estimates of 28%. Furthermore, we find that holding observable factors constant, occupational regulation is associated with a wage premium of 5%. This is lower than the 18% licensing premium found for the US but within the range of estimates for the UK.

I would love to see evidence on the distribution of the wage premium since I'm sure there are groups out there getting a hell of a lot more than a 5% premium! The other side of this coin is that there must be groups for whom occupational regulation results in little of the way of a premium. Does the form of regulation play a role here?

Another advantage of legal medical marijuana

Another post at the ProMarket blog highlights the cost advantages of medical marijuana, at least in the institutional framework for healthcare currently in use in the US.

A new working paper by University of Georgia researchers shows that medical marijuana leads to sharp drops in the number of prescriptions for branded drugs.The paper estimates savings of up to $1.5 billion per year in Medicaid spending if medical marijuana was legalized in all 50 states.

The blog post goes on to argue that the ideas of George Stigler might offer a potential explanation as to why the countrywide legalisation of medical marijuana has not happened yet.

One possible reason:

Some, including journalist Lee Fang and the Washington Post’s Christopher Ingraham, have suggested that this might have something to do with resistance from pharmaceutical companies, longtime rivals of marijuana reforms. Pharmaceutical companies have lobbied against marijuana legalization on both the state and federal level, and spent millions on anti-legalization campaigns and funding for academic research that presented marijuana as dangerous.

What the research discussed in the blog post shows is that in states that instituted medical marijuana programs, legalisation was followed by a sharp drop in the number of prescriptions for branded drugs for which marijuana could be used as an alternative. Pharmaceutical companies would not be too happy about this.

In July, the Bradfords [authors of the research] published a first-of-its-kind paper that examined the effects of legalized medical marijuana on doctors’ prescribing patterns by examining data from the Medicare Part D database between 2010 and 2013.1) Their paper focused on nine categories of drugs: pain (sales-wise, the most lucrative category for pharmaceutical firms), anxiety, depression, glaucoma, nausea, psychosis, seizures, sleep disorders, and spasticity. They found that the 17 states that had medical marijuana programs in 2013 have seen a sharp drop in the number of prescriptions, particularly for painkillers. In states where medical marijuana was legal, doctors prescribed 1,826 fewer daily doses of painkillers per year, 562 fewer daily doses of anti-anxiety drugs, and 265 fewer daily doses of antidepressants.

The Bradfords have since utilized the same methodology and applied it to Medicaid, where the population is younger and therefore more prone to use medical marijuana.2) In a new working paper, they find that the trends they observed in their previous paper were much more pronounced, and that medical marijuana was followed by a drop of 3-5 percent in the number of prescription in seven of the nine categories they examined.3)

The Bradfords’ research also indicates that legalizing medical marijuana could benefit taxpayers, in the form of reduced spending on health care. States that legalized medical marijuana by 2013 saved $165.2 million per year on Medicare spending alone, according to their research. If all states had implemented medical marijuana laws in 2013, they estimated, overall savings to Medicare would have been $468 million—just under 0.5 percent of all Medicare Part D spending in 2013. When it comes to Medicaid, the savings are much larger, and could be as high as $686 million.4) If all 50 states had legalized medical marijuana by 2014, according to their estimates, that could translate to savings of $1.5 billion per year in Medicaid spending.

What part does George Stigler's idea of regulatory capture play in the pharmaceutical companies opposition?

In a recent conversation with ProMarket, W. David Bradford said that while he and his daughter didn’t write their initial paper with regulatory capture in mind, they have “come around” to the view that pharmaceutical companies are opposed to reforming marijuana laws.

“The biggest reaction we’ve gotten to this paper, that I hadn’t anticipated, was that people interpreted our results as if we were providing evidence for why pharmaceutical companies would oppose the legalization of marijuana. Having now looked at the issue more since our paper came out, I do think we are seeing activities on the part of the pharmaceutical industry to protect their interest in mostly-branded drugs that treat these conditions,” he said.

The Bradfords’ two papers show that people use marijuana as medicine, and not just recreationally. They also seemingly show that pharmaceutical firms have a reason to worry about further liberalization of marijuana laws. Yet initially, Bradford said, he was “really skeptical” of the notion that the pharmaceutical industry would oppose legalization.

“I thought ‘why would pharmaceutical companies oppose this? If they could get a new drug approved based on whole-plant marijuana, and it was a blockbuster, they could get at least five years of exclusivity out of it, and lots of patent protection if it was a patentable product.’ But after thinking about it more, and being made aware of the amount of money that pharmaceutical companies are spending to lobby against marijuana legalization, I’ve come around to the view that it’s not likely that whole-plant could be patentable, or gain any kind of market exclusivity from the FDA. Even if you could somehow short-circuit some of the trials, it’s still going to cost hundreds of millions of dollars to get a drug through the FDA approval process. And if it’s a whole-plant product, and it is proven to work, and it gets approved and is rescheduled somehow, and then people could just grow it in their backyards, what’s their incentive?” said Bradford.

If you have regulators, you will have regulatory capture and current market players will use their influence to keep competitors out.

The interesting question is given New Zealand's health care framework, what are the cost advantages of legalised medical marijuana? If the results outlined above carryover to the New Zealand case then the cost savings could be large and thus well worth looking into.

Can you regulate your way to lower costs?

The answer, at least in some cases, is no. This is an example were regulations were put in place in the hope of restraining the growth of health spending, but failed.

In most states in the US, health care providers who seek to open a new hospital must obtain a "certificate of need" (CON) from a state board certifying that there is an "economic necessity" for their services. A new working paper, by James Bailey, published by the Mercatus Center at George Mason University, finds that states with CON laws spend 3 percent more on health care than other states.

Bailey discusses his work in a blog post at the ProMarket blog. He writes,

What does it take to open a new hospital or health facility? Certainly a building, equipment, supplies, and a staff of trained medical professionals. But in most states, this is not enough. Health care providers must also obtain a “certificate of need” from a state board certifying that there is an “economic necessity” for their services.

Certificate of need (CON) laws were passed rapidly between 1964 and 1980 in the hope of restraining the growth of health spending. By 1980, every state but Louisiana had a CON program, and the federal government was pushing states to adopt CON by threatening to withhold Medicare funds from states without it.

But by 1986, the feds were no longer convinced that this approach to keeping costs down was working, and they stopped pushing CON onto states. Since then 15 states have repealed their CON laws, allowing healthcare providers to make their own decisions about how to expand.

Bailey's research investigates how health care spending has changed in the 15 states that repealed CON compared to the 35 states that have not. The punchline from his study is,

I find that CON laws have not led to lower spending. In fact, states with CON laws actually spend 3 percent more on health care than other states.

In other words, not only have CON laws failed in their goal of reducing health care spending, they have backfired and driven spending upward.

An obvious question to ask is, Why? A bit of simple economic theory explains the result.

High spending can be driven by two factors: a high quantity of sales, or high prices. By restraining the supply of new health care, CON laws try to push quantities down. But with fewer competitors entering the market, existing providers find themselves able to raise prices without jeopardizing their market. Because the demand for health care is relatively inelastic, supply restrictions like CON increase prices more than they decrease quantities, leading to an increase in total spending. While data on health care prices are notoriously difficult to acquire, my paper shows that hospital charges fall by 1 percent per year over 5 years in CON-repealing states relative to CON-maintaining states.

The moral of the story is, regulating your way to lower costs need not work.

Lobbyists are behind the rise in corporate profits

An interesting headline that comes from an article by James Bessen at the Harvard Business Review.

Corporate profits in the US are up. But is this good for society at large. May be yes, may be no. Economists have two hands!

First, higher profits create greater economic inequality. Rising aggregate profits correspond to a decline in labor’s share of output, contributing to stagnant wages. Also, greater profits for some corporations but not others may create greater wage inequality.

and

Second, the rise in profits might represent a decline in competition and, with that, a decline in economic dynamism. While a dynamic, competitive economy rewards innovative firms with high profits and punishes poor performers with low profits, sustained aggregate profits suggest, instead, that firms are able to get away with higher prices because competition is limited. Firms engage in political “rent seeking”—lobbying for regulations that provide them sheltered markets—rather than competing on innovation. If so, then high profits portend diminished productivity growth.

Or

But there is a more optimistic narrative about the rise of profits. Perhaps profits are rising because firms are increasingly making profitable investments in new technology, in IT, or in their organizational capabilities. In this account, high profits represent increased economic dynamism.

So which is it? The answer matters.

Bessen writes,

In a new research paper, I tease apart the factors associated with the growth in corporate valuations relative to assets (Tobin’s Q) and the growth in operating margins. I account for the roles of R&D, spending on advertising and marketing, and on administrative costs, including IT. I also consider investments in lobbying, political campaign spending, and regulation; and I look for links between rising profits and industry concentration and stock volatility.

I find that investments in conventional capital assets like machinery and spending on R&D together account for a substantial part of the rise in valuations and profits, especially during the 1990s. However, since 2000, political activity and regulation account for a surprisingly large share of the increase.

He continues,

Much of this result is driven by the role of regulation, so it is important to understand the link between regulation and profits. Lobbying and political campaign spending can result in favorable regulatory changes, and several studies find the returns to these investments can be quite large. For example, one study finds that for each dollar spent lobbying for a tax break, firms received returns in excess of $220.

Which is why many economists want government kept out of business as much as possible. Light-handed regulation being best. It minimises the rents on offer.

A more interesting and less obvious question is how can regulation in general should be associated with higher profits? Isn't one big reason for regulation to keep profits down? Bessen explains,

Yet even regulations that impose costs might raise profits indirectly, since costs to incumbents are also entry barriers for prospective entrants. For example, one study found that pollution regulations served to reduce entry of new firms into some manufacturing industries.

Even when regulators try to reduce prices, firms can benefit. For example, in 1992 Congress passed the Cable Television Consumer Protection and Competition Act in response to high cable TV rates. Regulators expected cable prices to fall by 10%. Instead, however, cable companies changed their programming bundles, prices did not fall, and corporate valuations increased.

In short, regulators don't have the knowledge to fully predict the reactions of the firms they regulate and this can result in unintended consequences. Bessen goes on to say,

The pattern around the 1992 Cable Act is representative: I find that firms experiencing major regulatory change see their valuations rise 12% compared to closely matched control groups. Smaller regulatory changes are also associated with a subsequent rise in firm market values and profits.

So Bessen's research supports the view that political rent seeking is responsible for a significant portion of the rise in profits. Again this tells us we want to keep government and business as far away from each other as possible. The more governments interject themselves into the world of business the greater the opportunity for firms to influence government actions to the firm's advantage.

Bessen concludes by saying,

Two characteristics make these changes particularly worrisome. First, the link between regulation and profits is highly concentrated in a small number of politically influential industries. Among non-financial corporations, most of the effect is accounted for by just five industries: pharmaceuticals/chemicals, petroleum refining, transportation equipment/defense, utilities, and communications. These industries comprise, in effect, a “rent seeking sector.” Concentration of political influence among a narrow group of firms means that those firms may skew policy for the entire economy. For example, the pharmaceutical industry has actively stymied efforts to address problems of patent trolls that affect many other industries.

Second, while political rent seeking is nothing new, the outsize effect of political rent seeking on profits and firm values is a recent development, largely occurring since 2000. Over the last 15 years, political campaign spending by firm PACs has increased more than thirtyfold and the Regdata index of regulation has increased by nearly 50% for public firms. However much political rent seeking has affected economic dynamism and inequality so far, the effect is likely to be greater in the near future.

The only way you can hope to, at least, limit business influence is to create a system whereby the payoffs to influence are small because governments interfere little. The irony of having lots of regulation is that you make rent seeking profitable, and firms go where the profits are. Lots of regulation can result in lots of lobbying since there are lots of  rents to be had.

Of course firms are not the only groups that can gain by influencing governments and regulators. Trade unions or consumer groups or environmental groups or churches, or health groups or universities or ..... all can gain by trying to influence governments in ways that help that particular group. If there are rents on offer then they are available to all.

A "pretense of knowledge" problem? 2

In the comments section to my previous post on this topic Donal Curtin makes the point that

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?

My point here would be, and let me go all Coaseian for a moment, that comparative institutional analysis is needed. The first thing the regulators have to show is that their "wrong solution" is likely to be better than the market "wrong solution". It is possible that the regulated outcome is worse that the unregulated one. As Coase said in an interview with Reason magazine in 1997:

Reason: You said you're not a libertarian. What do you consider your politics to be?

Coase: I really don't know. I don't reject any policy without considering what its results are. If someone says there's going to be regulation, I don't say that regulation will be bad. Let's see. What we discover is that most regulation does produce, or has produced in recent times, a worse result. But I wouldn't like to say that all regulation would have this effect because one can think of circumstances in which it doesn't.

Reason: Can you give us an example of what you consider to be a good regulation and then an example of what you consider to be a not-so-good regulation?

Coase: This is a very interesting question because one can't give an answer to it. When I was editor of The Journal of Law and Economics, we published a whole series of studies of regulation and its effects. Almost all the studies--perhaps all the studies--suggested that the results of regulation had been bad, that the prices were higher, that the product was worse adapted to the needs of consumers, than it otherwise would have been. I was not willing to accept the view that all regulation was bound to produce these results. Therefore, what was my explanation for the results we had? I argued that the most probable explanation was that the government now operates on such a massive scale that it had reached the stage of what economists call negative marginal returns. Anything additional it does, it messes up. But that doesn't mean that if we reduce the size of government considerably, we wouldn't find then that there were some activities it did well. Until we reduce the size of government, we won't know what they are.

My issue is that regulators don't seem to think like this, they just seem to assume that whatever they do will be better than what it occurring without their intervention. And I just want them to show that their regulated outcome is likely to be better than the current, albeit imperfect, market situation.

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.

and

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.

Another example of the law of unintended consequences

One of the more obvious problems with economic regulation is the law of unintended consequences. You can end up with results that are the opposite of those intended. What happens when product liability is strengthen in a world where production is vertical and crosses jurisdictional lines? If goods are produced by an upstream national or international firm and improved or distributed by local firms downstream does a strengthening of product liability have unintended consequences on product sales and consumer safety? This question is asked in a new NBER working paper, Unintended Consequences of Products Liability: Evidence from the Pharmaceutical Market by Eric Helland, Darius Lakdawalla, Anup Malani and Seth A. Seabury. The paper's abstract reads,

In a complex economy, production is vertical and crosses jurisdictional lines. Goods are often produced by an upstream national or global firm and improved or distributed by local firms downstream. In this context, heightened products liability may have unintended consequences on product sales and consumer safety. Conventional wisdom holds that an increase in tort liability on the upstream firm will cause that firm to (weakly) increase investment in safety or disclosure. However, this may fail in the real-world, where upstream firms operate in many jurisdictions, so that the actions of a single jurisdiction may not be significant enough to influence upstream firm behavior. Even worse, if liability is shared between upstream and downstream firms, higher upstream liability may mechanically decrease liability of the downstream distributor and encourage more reckless behavior by the downstream firm. In this manner, higher upstream liability may perversely increase the sales of a risky good. We demonstrate this phenomenon in the context of the pharmaceutical market. We show that higher products liability on upstream pharmaceutical manufacturers reduces the liability faced by downstream doctors, who respond by prescribing more drugs than before.

So when liability is increased on the upstream firm we can see greater risks being taken by the downstream firm and an increase in the sales of a risky good, which it seems fair to assume is not the intended outcome of an increase in product liability.