Market clout

Does privatization always improve economic performance?



The government’s planned sale of large enterprises, “The People’s IPO,” allegedly would make Kazakhstan’s economy leaner, meaner and competitive. In reality, competitiveness depends not on whether individuals own a firm but on the firm’s clout in the market. Privatizing Kazakhtelecom (the government still owns 51%) wouldn’t make the market for telecommunications competitive in the sense that no seller or buyer would be large enough to affect the market price. Given its track record, Kazakhtelecom will dominate the market regardless of whether it has one owner or many. It has 90% of the fixed-line subscriptions, and it is the only holder in Kazakhstan of a license to Long Term Evolution, an advanced wireless standard, according to OpenNet Initiative and Halyk Finance, respectively.

The government can take one of two courses: Recognize that Kazakhtelecom is a virtual monopoly and regulate it accordingly; or break it up into many firms, each too small to set the market price. The justification for the latter course is that small firms must fight to survive by pleasing consumers, whereas a firm that dominates the market need not cater to anyone.

This course is ill-advised. A national infrastructure for telecommunications, such as fiber-optics links between the cities, costs much to build. Net fixed assets for Kazakhtelecom were 227 billion tenge (about $1.5 billion) in fiscal 2011, 54% of total assets, according to Bloomberg News. There is no point in throwing bad money after good by inducing a new firm to build a duplicate infrastructure, particularly when fiber optics networks tend toward excess capacity.

Perhaps the government could retain control of the infrastructure and carve up Kazakhtelecom into small firms that would lease this network in order to sell services. (Roughly 100 Internet providers have been leasing in recent years, according to OpenNet.) Competition among them would hold down prices.

The first course – regulation – is deceptively simple. As a private firm, Kazakhtelecom would control the infrastructure; but the government would limit its price to consumers, subsidizing it if necessary so that it would earn a normal rate of return. Over time, however, the government may rely increasingly on Kazakhtelecom for market information vital to estimating the size of the subsidy, since its own data – obtained when the firm was a public enterprise -- may become obsolete. Kazakhtelecom may be tempted to fudge the numbers.

Going, going, begone


Here’s a hybrid approach: The government could auction off a lease of the infrastructure to the private firm that bids the lowest price at which it would sell to consumers, for a given subsidy; or the government could specify the consumer price and then grant the lease to the firm that bids for the smallest subsidy. The beauty of the auction is that it induces the firm to provide accurate information about its costs, in the form of a bid. However, the experience of United States governments with auctions in a similar market -- cable television -- has not been ecstatic. A firm might enter an artificially low bid and then, after winning the auction, force government officials to provide a larger subsidy than it had originally requested. In Milwaukee, the winning bid promised to provide 108 channels for a monthly fee of $4.95. What Milwaukee actually got was 54 channels for $11.95, according to regulatory economists Kip Viscusi, Joseph Harrington and John Vernon.

An American drama may shed light on problems that Kazakhstani regulators might face in loosening constraints on the telecommunications market. For decades, American Telephone & Telegraph (AT&T) enjoyed a protected position as a regulated monopoly. It was known as the safest financial investment in the country. But by the 1960s, demand increases as well as cost-cutting innovations were expanding the telecommunications market beyond the point where one firm could serve it efficiently. Gradually the federal government deregulated the submarkets such as the one for a firm providing internal phone services. By the early 1980s, AT&T’s monopoly was confined to the market providing phone services between cities – and it was coming under attack there, too.

The question was whether to let AT&T compete in submarkets that had already been deregulated. On one hand, the company might be able to cut costs for the deregulated good because of synergies with production of the regulated good. For example, experience with local phone service might reduce the cost of long-distance service. On the other hand, AT&T might cunningly use guaranteed profits in the regulated market to pay for price-cutting in the deregulated one; after driving rivals out of the latter market, it could charge the highest price that buyers could bear.

In 1982, a pact with regulators, supervised by the courts, shut out AT&T from deregulated markets. It slipped into a coma. In 2005, it was acquired by one of its own spinoffs, Southwestern Bell.

One problem may be that regulators balk at experimenting, note Viscusi, Harrington and Vernon. Change is politically risky since it may raise prices or cripple an industry. Also, deregulation curtails the agency’s duties, reducing “power, prestige, and income for the regulators.” So we may get too much change too late. – Leon Taylor, tayloralmaty@gmail.com



Good reading

W. Kip Viscusi, Joseph E. Harrington, Jr., and John M. Vernon. Economics of regulation and antitrust. Fourth edition. Cambridge, Mass.: The MIT Press. Chapter 15 discusses the AT&T case.



References

Bloomberg News. Kazakhtelecom JSC. 2012. bloomberg.com

Kazakhtelecom. General information. April 12, 2012. telecom.kz

Timur Omoev. Key takeaways from meeting with managers. May 15, 2012. halykfinance.kz

OpenNet Initiative. Kazakhstan. 2010. opennet.net .