Microeconomics and public decision making when geography matters

European Economic Review 34 (1990) 249-271. North-Holland

MICROECONOMICS

AND PUBLIC DECISION GEOGRAPHY MA’ITERS

MAKING

WHEN

Claude HENRY Ecole Polyrechnique. 75005 Paris, France

I. Introduction In the agreement with A. Atkinson and M. Bruno about how to share between us our common theme, I inherited those subjects for which not only economics but also geography have some relevance to public policy. Defined in this loose way, my brief still proved too broad. Indeed, what I am supposed to do is not to review pieces of microeconomic analysis but to trace their impact on actual public policy issues. Therefore I have to make these issues intelligible, and this inevitably takes a toll of the limited space I have at my disposal. So, I decided to restrict myself to two sets of issues and to three economic approaches. The issues are ‘environmental and natural resources’ on one hand, and on the other hand, ‘communication networks’. As to the approaches they are: assessing, pricing and regulating. The lecture deals successively with these three approaches, as applied to the two sets of issues. For most of these, I have been able to consult people who have played some role in their handling, be it a role of inspiration or a role of implementation. I cannot thank them individually here, but I nevertheless want to let them know the extent of my gratitude. They all have helped to make what - I hope - is a genuinely European inquiry, and not one focusing on my own country.’ But one name I want to mention: Dr Steenbergen who, a few weeks before he died after a long illness, took the trouble of sending additional material for my benefit. Let me stress one last point in this introduction. The subject matter of the lecture is to examine processes wherein some amount of microeconomic analysis has interacted with the course of events. The interaction may be very simple, as in the case of Leon Walras in 1877 when writing his paper ‘L’Etat et les chemins de fer’ in order to meet a request by the Department of Transport of the Swiss Canton de Vaud. But, most of the time, things are much more complicated, with many economic and political forces involved, and with no clear causal links. ‘Faulhaber and Baumol (1988) and Deleau (1987) cover a broader range of issues; but the former is dealing mainly with American experiences, while the latter is restricted to France. 0014-2921/90/53.50 0

1990, Elsevier Science Publishers B.V. (North-Holland)

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Indeed, starting with the assessment of transport systems, immediately plunge into a world of multiple interactions.

we shall

2. Assessing By the beginning of the seventies, some public administrations or utilities in European countries had developed methods to produce systematic economic assessments of their investment projects. In most cases the understanding of these methods was confined to narrow circles of specialists. It even happened that officials in the respective Ministries of Finance praised such methods without being exactly aware of their logic and effects. A prominent package of methods already in use at that time is the COBA Manual (COBA for Cost Benefit Analysis), which had been worked out by engineers and economists in the U.K. Department of Transport. COBA was, and still is, used to assess the trunk road projects developed by the regional offices of the Department of Transport. By the time, COBA was unique in Europe in that it had drawn the attention of an unusual variety of people, from Parliament to Friends of the Earth. Indeed Parliament and public opinion more and more voiced concern about the way new trunk roads were laid out by the Department of Transport. They complained about what they considered unwarranted secrecy during the preparation stages of the projects, as well as arbitrary in the selection by the Department of a so-called preferred route, and stubbornness in defending this route at the public inquiries. Opposition became so tough that important projects were blocked. In 1977, the Department of Transport had to accept that an independent commission be called to scrutinize the COBA methodology. This commission (‘Advisory Committee on Trunk Roads Assessment’) became known as the ‘Leitch Committee’, after the name of its chai_rman. None of the eight members’ of the Committee was coming from the Department of Transport; two among them were professors at the London School of Economics and Political Science. In its report, the Leitch Committee adhered to the genera1 philosophy of the COBA methodology as a tool for decentralizing allocation decisions within a coherent framework. Despite a number of suggestions for improvement, it was generally satisfied that COBA was in line with the relevant parts of microeconomic theory; the only serious criticism in this respect concerned design standards. On the other hand, the report severely criticized the forecasting techniques that were used to feed the assessments. They indeed tended to overestimate the numbers of vehicles in the future and their rates of use. As they also overestimated both the population growth and the 2They are G. Leitch, R. Beckham, J. Durbin, S. Glaister, P. Hall, M.H. Middleton, J.D.C.A. Prideaux and T.E.H. Williams.

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A motorway

251

vanishes

August, 1912 ‘me Minister] has decided to include in the Trunk Road Preparation Pool a scheme for

a new major route between Manchester and Shelfeld’. from Ministerial answers to questions in the House of Commons February,

1977

‘Plans for the Manchester-Sheffield motorway have been scrapped by the Government until the year 2000. The reason for delaying the 100 million pounds/m motorway is that not enough tragic will use it, says the Transport Ministry. The biggest shock was for MPs, councillors and officials from Yorkshire, the North and East Midlands and the North-West, who had arrived yesterday afternoon for a private meeting with Ministry spokesmen, expecting an announcement that the motorway was to go ahead’. from Sheffield Morning Telegraph, 19 February, 1977

economic growth, there was a cumulative effect which was all the more serious as the forecasts were presented in a way that inspired feeling of scientific rigor and reliability. The first recommendation, in the list at the end of the Leitch report, reads: ‘The Department should indicate the likely range of uncertainties involved in the forecasts and demonstrate the consequences of selecting different values within that likely range. It should never put itself in the position of appearing to defend a single figure as if it was uniquely correct’ (page 134). The COBA Manual has been revised along the lines recommended by the Committee. Changes in forecasting techniques were far-reaching. For a long time, high forecasts for key parameters had caused the assessments to produce high rates of return; these helped the Department of Transport to secure public money from HM Treasury. With forecasts seriously revised downwards, the rates of return were greatly reduced. Projects were reduced in size, delayed or simply dropped. For instance, the cancellation of the motorway project linking Manchester and Sheflield through the Peak District National Park was all the more significant as the project was in the final stage of technical preparation by the Department of Transport (see A motorway vanishes). There have also been global reassessments - and ensuing revisions - of national trunk road programmes in Germany and in Switzerland. In Switzerland a commission - the Commission Biel, after the name of its chairman - was endowed with large powers of investigation; this commission was neither dependent on federal nor on cantonal administrations. The Zurich Eidgeniissische Technische Hochschule was in charge of preparing the reassessments. The Federal Government endorsed all the proposals made in the Commission Biel (1981) final report. In France, there has been nothing comparable to the Leitch Committee, nor the Commission Biel; this might contribute to explain that French road engineers are still in a position to

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build luxurious motorways that in any foreseeable future will accommodate less than 10,000 vehicles per day [see Grandjean and Henry (1984)]. The Leitch Committee paid special attention to the problem of design standards. They recommended that whenever possible design standards be reintegrated in the economic analysis and dealt with as decision variables: ‘the use of economic appraisal in the design field is, we believe, highly desirable’ (page 93). Thereby they advocated more flexibility in project assessment. This is a point that economists have stressed again and again during the last ten years or so, having in mind not only road projects, but also dams, drainage and irrigation schemes, rail networks, . . . They did not always succeed in convincing the project managers, but significant progress has been observed. One more road case should be mentioned in this respect, that of the N9 motorway in the upper Rhone Valley, in Switzerland. Almost everybody there wanted a motorway. But the engineers in charge of the project insisted on following ‘best-practice’ design standards, that made their project extremely costly and so intrusive that it faced outright rejection from the inhabitants of the valley. A mediator was then designated by the Federal Government. He gathered a team of experts from the Ecole Polytechnique de Lausanne, where he himself was a professor of urban planning and transport economics. He had extensive consultations with representatives of the local communities involved. On the basis of both studies and consultations, he designed a - by far - more flexible project, particularly in terms of gradient and curvature. This made possible savings such as: volume of construction materials reduced by a factor 2, length of intruding sections reduced by a factor 4, number of sites of scientific interest or natural beauty affected reduced by a factor 3 [see Bovy (1983)]. This project is now being realized. In the design of the new European high speed rail network, the value of flexibility is explicitly taken into account. This has been the case from the very beginning, when a dual rail was preferred for the Paris-Lyon TGV to a monorail. Indeed with a dual rail, expensive works are not needed to enter the city centres; it is also possible for the TGV to circulate beyond Lyon, for example to reach Marseille on the existing track, before the new track is completed. Nowadays, TGV projects are either realized, planned or considered in several European countries [see Communaute Europeenne des Chemins de Fer (1988)]. A number of them involve more than one country. For example the link between Portugal, Spain and France; and the so-called ‘TGV Nord from Paris to Brussels, and from Brussels either to Kiiln or to Amsterdam [see SociCtt Nationale des Chemins de Fer Francais (1986)-J; and also the ‘TGV Est’ from Paris, via Strasbourg, to the South of Germany and the North of Switzerland [see Gemeinsame Deutsch-Franzosische Arbeitsgruppe (1989)]. A unified methodology has been developed to assess all such

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,

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Ludwlgshafen

I Kalserslautern

/

/Caarbriicken Forbach

Strasbourg

Paris

Kaiserslautern

Paris

w~~hStrasbourg

Existing m-m--

Upgraded New

Fig. 1

Table 1 1985 Paris-Frankfurt Paris-Stuttgart Paris-Miinchen Rennes-Frankfurt

5h 53min 6h 08min 8h 42min

10h Zlmin

Variant 1

Variant 3

4h OOmin 4h 04min 5h 48min

3h 05min 3h 14min 4h 58min

6h ldmin

5h 45min

Note: From Gcmeinsamc Deutsch-Franziisiche Arbeits~ruppe ( 198%

projects; it is accepted in all the countries involved.’ It stemmed from the work done by an international task force which has been in charge of the TGV Nord, the latter being the more advanced among the international rail ‘It appears moreover that mic&conomic analysis is increasingly used to deal with various aspects of the rail sector [see for example Escribano (1988)].

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projects. Later on, it was used for the TGV Est. The study dealing with the link between Portugal, Spain and France is in progress along the same lines. As can be seen from fig. 1 and table 1, design flexibility is duly taken into account by this methodology. Comparing variants 1 and 3 is essentially comparing the benefits and costs of either building a maximum length of new track or having a mix of existing, upgraded and new track. The intertemporal value of flexibility has not been forgotten when assessing rail projects. Indeed, if one initially keeps the existing track on some sections of a link, one also keeps open the option to upgrade the track later on, or to build a new track. This has been discussed at length by the Direction de la Prkvision (1987) of the French Ministry of Finance, in connection with the possible ways of linking Paris with Lille, the Channel Tunnel and Brussels; option values [see Henry (1974)] have been considered. Flexibility in an intertemporal perspective is also the matter of general recommendations (‘Reversibility is therefore a factor which should be considered in appraisals’) in a Technical Guide for Government Departments that HM Treasury has prepared - and annually updates - for the benefit of those civil servants in charge of public projects. Economists have made a valuable contribution to cost-benefit analysis by reintegrating a variety of design standards as economic variables into the analysis. But now how far to go? Whenever only crops are threatened by flooding, it is straightforward to assess the costs and benefits of flood protection in purely economic terms. When unique natural habitats or when human lives are at stake, it is less straightforward. In a joint effort to assess a project affecting the Waddenzee, Dutch economists and ecologists have come to an agreement on how to mark off design standards from economic variables in the problem they had at hand [see Nederland Economisch Instituut en Rijksinstituut voor Natuurbeheer (1978)J. The project to be assessed was the construction of a new harbour on the Balgzand, i.e. at the southern limit of the Waddenzee (see fig. 2). The Balgzand is made of 7.000 hectares of mud flats alternatively covered and exposed by the tide, and irrigated by a system of natural deep channels which always remain under water. It is one of the rare areas of mud flats combining the advantages of being well sheltered, well irrigated and in the immediate proximity of the North Sea. At high tide, fish, crab, and shrimp come to feed in the mud flats. Before low tide, when the flats are exposed, they can either return to the sea or remain in the channels permanently filled with water. The shelter provided by these channels is essential for the early stages of many forms of marine life [see Dankers (1978)J. On the other hand, the Balgzand is also a most convenient -place to build the harbour facilities that were needed for the exploitation of those North Sea oil and gas reserves that belong to the Netherlands. After years of controversy, the local authorities proposed that an economic and ecological study be carried out by experts from the Nederlands

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25s

WADDENZEE

,

z Fig. 2

Economisch Instituut (based at Erasmus Universiteit in Rotterdam) for the economic part, and’ the Rijksinstituut voor Natuurbeheer (National Institute for Nature Management, which happens to have a department of marine ecology based on Texel island) for the ecological part. The study was to be supervised by a steering committee consisting of representatives from the central government, the local authorities and two conservation voluntary bodies active in the Waddenzee area. There was quick agreement on one point: nothing was to be done which would seriously disturb the basic functioning of the natural system in the

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Balgzand. Indeed, having already reached an ecologically impoverished state, the country could no longer afford such a loss. From this general point of agreement, a second one was derived: all the parties accepted the demonstration by the Rijksinstituut voor Natuurbeheer that the basic functioning of the natural system in the Balgzand was dependent on maintaining the free circulation of water in the deep channels, i.e. maintaining the quality of the connection between the sea and the Balgzand’s mud flats. Consequently, among the technically feasible alternatives for setting the harbour facilities, all those which would close channels were immediately dismissed. Only alternatives which had not that effect were considered acceptable and were assessed by the Nederlands Economisch Institut. From this assessment, it emerged that among all the acceptable alternatives, there was none that would be economically viable. The conclusion was that the project should be abandoned. This conclusion was final and taken as such by all parties in the steering committee. Not one of them came back to question the procedure which had been followed to reach it. This procedure eliminated from the beginning every alternative that failed to meet a commonly agred upon ecological criterion, without any need of further examination. In a second phase, acceptable alternative were designed with maximum flexibility and assessed so as to embrace all costs and benefits that could possibly be evaluated in monetary terms, including those effects on the natural environment which, without being of a fundamental nature, had nevertheless to be taken into account at that second level.

3. Pricing While not yet leaving the domain of environmental issues, we now turn to pricing problems. Table 2 illustrates what uses have been made in Europe of price mechanisms to try and influence behaviours towards natural resources.* Some additional information will help to appraise the significance of these endeavours. The water etlluent charges in France are too low to have a nonnegligible incentive effect of their own. However the revenue raised by the River Basin Agencies through these charges is substantial and it is used to subsidize the expenses incurred by the polluters in order to reduce pollution. In this way the marginal cost of reducing pollution is sufIiciently decreased for the charge to actually have a nonnegligible incentive effect. The eficiency of the Dutch water eilluent charges is somewhat paradoxical: when they were introduced, they were not meant to correct the behaviour of the polluters, but only to raise revenue. But the amount of ?he difference between the prices of leaded and unleaded petrol has also had a significant effect in some European countries, for example Britain, Sweden and Switzerland.

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Table 2 Incentive effects of economic instruments for environmental protection. Efluent charges

France Germany Netherlands Sweden

water pollution water pollution water pollution air pollution

+ + ++

1

Product charges

Finland Italy Norway Sweden

nonreusable beverage containers nonbiodegradable plastic bags nonreusable beverage and food containers nonreusable beverage containers

+ t + +

Deposit-refund systems

Denmark Finland Netherlands Norway Sweden

reusable beverage containers reusable beverage containers reusable beverage containers nonreusable beverage containers reusable beverage containers car hulks reusable beverage containers recyclable aluminium tins car hulks

++ ++ ++ t ++ + ++ ++ 1

Markets for rights

France Germany Iceland

transferable development rights in rural communities compensation between air pollution sources transferable fishing quotas

w -9 ++

Meaning of the symbols + = nonnegligible incentive effect + -I- =signilicant incentive effect f=introduced recently, at a significant level + =experimental l=signilicant incentive effect when_ introduced; no longer so ‘Compiled from OECD (1989), Amason, R. (1989). and from various private communications.

revenue sought and the modes of collection brought about had remarkable incentive effects, for which the system is now praised. Wherever it exists, the combination of charges on nonreusable containers and of refundable deposits (ranging from 0.10 to 0.30 ECU per object) on reusable containers seems to work reasonably well, thus fulfilling the expectations of the economists who had advocated them. Of special interest is the way aluminium tins are dealt with in Sweden. Aluminium tins are indeed nonreusable containers, but aluminium may be recycled. Moreover the deposit per tin has been deliberately increased (from 0.04 to 0.08 ECU) in order to reach a predetermined objective set by public authorities in terms of a minimum recycling ratio, i.e. 0.75. To run the system, a private company, AR Svenska Returpack, has been created as a

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joint venture between breweries, package industry and retailers. It is up to that company to organize the collection and the repayment of deposits, as well as the recycling of the returned tins. When the system was started, in 1983, the deposit was set at 0.04 ECU. The reactions of the economic agents brought about a recycling ratio fluctuating between 0.6 and 0.7, that corresponds to roughly 400 million tins a year but is below the objective of 0.75. Returpack and the public authorities then considered raising the deposit. In 1987 it was decided that the deposit should be doubled. The recycling ratio has reached 0.8 in 1988. Acid rains have been a serious concern in Sweden for more than twenty years. And Swedish economists have been swift to propose emission charges in order to deal with the sulphur dioxide emissions that did so much to contribute to acid rains. For instance the Swedish National Case Study prepared for the 1972 UN Stockholm Conference was on acid rains, and it had a section discussing the introduction of charges on sulphur emissions. Time passed, rains became more and more acid and Swedish people more and more concerned. Economists worked out their proposals for emission charges, and put them forward in papers, reports and official commissions. Till the mid-eighties, however, almost nobody outside academic circles took this approach seriously. There was even some hostility to what detractors called ‘abstract theory’, and others ‘licences to pollute’. Meanwhile it was becoming more and more obvious that traditional administrative regulation had failed, just as in other countries, including East-European ones as Ery and Forgacs (1987) put it bluntly: ‘The idea that the government in a socialist economy could achieve its objectives of environment protection solely by legal and administrative measures has already proven wrong’ (page 20). In 1987-1988 political decision-makers were in need of something else, even in urgent need, because of the pressure from public opinion and of the imminence of a general election. The Green party was up in the polls, and, in sharp contrast with its previous positions, declared itself in favour of emission charges. The economists’ proposals had been sleeping for years. They were suddenly aspirated into a political bandwagon; the result in 1989 is a strong majority in the newly elected Parliament for significant and immediate charges on both sulphur and chlorine emissions.5 In Britain, similar concerns recently came on the front page of the newspapers (see Prospects and contradictions). Markets in air pollution rights have .been extensively discussed, and experimented with some success in the U.S.A. There is nothing comparable in Europe yet. However, various European countries have embarked on limited experiments or on studies of specific projects; this is the case in Germany, in the Netherlands and in Scandinavian countries. ‘On this issue of acid rains in Sweden, I have greatly benefited from an unpublished memorandum by KG. Mller.

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2S9

Prospects and contradictions. of tax on pollution may be adopted, Patten hints: Mr. Chris Patten, the Environment Secretary, yesterday hinted the Government might adopt the principle advocated in a report published on Tuesday - of taxing polluting products to discourage their use’. ‘Principle

from Financial Times, 17 August, 1989 backs use of economy to save environment: [. . .] In an interview with BBC radio, Mr Patten said: “One of the diflicult jobs for politicians is to persuade people that many of the best things in life are not actually free. What we have to make sure is that people recognise that environmental quality is not a cost-free option”.’

‘Patten

from The Independent,

17 August, 1989

Britain’s second biggest power station is to be sold off to the private sector without needing to be fitted with anti-pollution equipment costing an estimated 600 m. The move would enable PowerGen, one of the two huge generating companies being created under electricity privatisation, to reactivate the giant Isle of Grain oil-fired station in Kent much more cheaply. But it is being seen in some quarters as a blatant sweetener in the run-up to the Government’s sale of the industry. c. *-1 Coal industry sources complain that the station will escape the cost of fitting equipment to cut sulphur dioxide emissions - a big contributor to acid rain - while coalfired stations face a hefty environmental clean-up bill. The type of fuel oil used to Fre the Isle of Grain plant creates three times as much sulphur pollution as equivalent coal-fired stations’. ‘6OOm Power

Sell-off

Sweetener:

from The Independent.

15 August, 1989

Markets in development rights have been discussed in a number of papers, but out in the field they have remained local curiosities. The idea has, however, helped a handful of rural communities in the South of France, as well as in Vermont and California, to make compatible the protection of their environment, a limited amount of residential development, and more or less equitable sharing of the increase in value of the land where development takes place. Markets - at least transactions - in transferable fishing quotas start becoming a reality. As Hannesson (1989) writes, ‘Since the introduction of the 200-mile exclusive economic zones, more and more fish stocks are being managed by annual catch quotas. [.. .] In order to achieve economic efficiency, it is necessary that the individual quotas be transferable and valid for a long period of time’. However the total allowable catch cannot remain fixed on a long period, as it depends on natural factors out of human control. This is a second reason why transferability is useful, not only between individual quota holders but also between them and a collective authority, that might buy quotas in years when the total allowable catch has to be reduced and might sell quotas in years when it is possible to expand the total allowable catch. New Zealand has opened the way for this form of

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Stockholm to charge car commuters.

‘Stockholm (Reuters) - The Stockholm local government has agreed to propose a monthly fee of 300 kronor on cars entering the city to encourage motorists to use public transportation. The plan is part of an anti-pollution drive designed to prevent an increase in the half million cars that enter Stockholm every day. The fee, equivalent to 545 and conditional on central government legislation, is due to be introduced in September next year. City of!Lzials said it was hoped that the plan would raise about 300 million kronor, which will be invested in public transportation*. from - International Herald Tribune, 31 May, 1989 The Swedish Crown is worth approximately 0.15 ECU, and the Norwegian slightly less.

Crown

fisheries management, and Iceland is the first European country to follow, albeit without having an authority buying and selling quotas [see Arnason (1989)]. Charging car commuters is a way of pricing a limited resource. It is a way that economists tend to support but that the general public seems to dislike. Cars in city centres create congestion and pollution; they overconsume space and natural resources. A number of city authorities try to mitigate this imperfection by subsidizing substitutes to car use, mainly public transportation. Some have considered charging car use in city centres. Despite its limitations, the example of Bergen is presently the most interesting in Europe. There has also been a recent but limited initiative in Stockholm (see Stockholm to charge car commuters). With about 300,000 inhabitants, Bergen is the second largest city in Norway. It lies between a fjord and mountains, so that only very few roads give access to the city centre; geography makes it easy to install a toll system. This has been done and the system started in 1986 along the lines indicated in table 3. Nowadays it attracts study groups from countless cities in Scandinavia, be they large or small; also delegations from Britain and Germany have been received. Economists from the Norwegian School of Economics had taken part in discussions during the designing of the system. But they were in favour of significantly higher tolls, payable at peak hours only, between 6a.m. and lOa.m., for instance. In that case the incentive effects of the system would have been significant. The city authorities take much more interest in the collection of revenue than in the correction of an allocative imperfection. The tolls collected are spent on building by-passes through the surrounding mountains with the objective of keeping the long-distance traffic away from the city centre. Would it however not be more efficient to use the toll system as an effective incentive device for reducing congestion and pollution in the city centre, while supplementing the revenue from other sources? And,

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Table 3 The toll system on the roads giving access to the city centre in Bergen (Norway).’ System stoned in 1986 Tolls

5 Nkr for a car coming into the city between 6a.m. and 10p.m. (no toll on Saturdays and Sundays) or 100 Nkr per month or 550 Nkr per half year These amounts are doubled for vehicles with more than 3.5 tons loading capacity

Revenue raised

1986

56 million Nkr 1987 58 million Nkr 1988 59 million Nkr

Public parking in the city centre

The price per hour is typically 10 Nkr ‘From information given by the Bergen Bridge and Tunnel Company.

anyway, within ten years all the by-passes needed around Bergen will have been built, and tolls will no longer be needed for that purpose. It is clear that the system does not work presently as economists would like it to work. But it will probably be much easier to change the way it works than it has been to create it. It has been somewhat difficult to have it accepted by the people in Bergen; now it has come to be a feature of everyday life; this is a valuable asset in itself. And it may be that, in Scandinavia or elsewhere, another city takes up the system with more emphasis on its incentive properties, and in turn stimulates Bergen. Coupled with the proposals developed by some economists to price roads use [see Newbery (1989)], we might have here the embryo of a European policy in a very sensitive matter. 4. Regulating This last section is about large communication systems within which do coexist natural monopoly components and components where competition is feasible and is often considered desirable for efficiency. This topic is currently on many political agenda, and stimulates a lot of economic research, with significant interactions between both aspects. Let us start with a comparatively simple illustration. In Britain, the 1980 Transport Act deregulated the long distance bus services: by abolishing all the existing licenses on the long distance routes, it opened them to competition. Prior to deregulation, the market in England and Wales was dominated by one company, National Express. It was the only one operating nationwide. National Express’ position was specially strong on the main routes converging on London. The 1980 Transport Act did not dismantle National Express. The company even retained the city centre terminals that it owned; among

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12 Oiatributlon Companh

Fig. 3

them was Victoria Coach Station in London, a prominent example of a natural monopoly component in the long distance bus transportation system. The passing of the 1980 Transport Act was swiftly followed by sizable new entry. A period of intense competition - in both prices and types of service provided - ensued on the main routes. On most of the routes it served before 1980, it took National Express but a couple of years to suppress any active competion. By 1983, prices on these routes were substantially higher than on

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most other routes, where active competition had predominantly persisted. On the basis of data obtained from leaflets issued, during the period following the 1980 Transport Act, by the operators on the main routes converging to London, Jaffer and Thompson (1986) have shown that the entry barrier resulting from terminal ownership was significant. And they concluded: ‘Our analysis suggests that separation of ownership between terminals and coach operation may be an important precondition for competition to be effective’ (page 63). It seems that this suggestion has been accepted by the British Government, as can be seen from Article 5.6 in the 1985 Transport Act: ‘If competition is to flourish, no operator should be in sole control of a bus station of a size or strategic position which would allow him to gain an unfair advantage by excluding other operators. The Government believes that major bus stations should be operated whether in private or public ownership on a commercial basis under arrangements which will provide for all operators to have equal opportunity of gaining access to them’. Most city centre terminals are now under control of local authorities; in London, Victoria Coach Station has been handed over to London Regional Transport Authority, which still is a public body. Electricity production, transmission and distribution is also an industry where separating natural monopoly from competitive segments is seriously considered in some Eruopean countries. In Norway, there are a great number of public and private companies producing electricity. But the largest one produces 30”/, of the total; this company, which is public, also owns the national grid. It has been proposed by economists in SAF - the Centre for Applied Research of the Norwegian School of Economics - that this company be split so that the grid might be run as a natural monopoly independently from any particular producer. This proposal is currently examined by the relevant administrative and political authorities in Norway. As another example, fig. 3, reproduced after the White Paper on ‘Privatising Electricity’ [Department of Energy (1988), pages 67)], shows that the British Government has decided to deprive the generating companies from the control of the grid. Those British economists, notably at the London Business School, who have worked on the reorganization of the electricity industry and who have advocated the principle of separation, seem to have been influential in this respect. 6 However, asThe. Ecoiomist (1989) po& out, the benefits of separation are far from being fully exploited, as the structure of the generating sector will not favour competition: ‘A complex ‘In the case of British Gas, which has been privatized as a whole in 1985, the management was in a much stronger position, because the Government wanted the privatization to be completed quickly (18 months) and to attract a large body of popular shareholders. With natural monopoly components and potentially competitive ones mixed up within the same firm, the regulation requirements become intricate or perhaps even self-contradictory, and thus largely inellicient [see Helm et al. (1989)].

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licensing system, for example, would not have been necessary if the Government had split up the Central Electricity Generating Board (CEGB) into live or six competing companies (rather than in two generating giants). But because power generation will be dominated by National Power and Power Gen, tough regulation to ensure that new competitors can enter the market (and are not then squeezed out) is a must.’ In the telecommunications industry, separation is often sought through the provision of free resale of leased lines. The Dutch case is most interesting in this respect. In June 1984, an economist, Dr Steenbergen, was appointed by the Dutch Government chairman of a commission to prepare a far-reaching reorganization of the Dutch Post and Telecommunications Administration (PTT). The objectives of such reorganization were clearly set. The economic prosperity of the Netherlands depends to a large extent upon their ability of accommodating international business, hence of offering in the most efftcient way the services they require. Paramount among these services are communication facilities. In this respect the institutional and organizational rigidity of the PTT at the time were increasingly seen as a handicap, although its technical efficiency was not questioned. In 1985, the Commissie Steenbergen produced a report which was remarkable for the sharpness of its proposals. Even more remarkable was the fact that the Dutch government endorsed these proposals almost completely in the 1988 Telecommunications Law (see Economic efficiency in telecommunications: The Dutch way). A private company, PTT Nederland, has now taken the place of the former administration. It has two independent subsidiaries, PTT Post and PTT Telecom. For the time being, no share in these companies has been sold to private investors. But their status protects them against administrative interference in their management and gives them the flexibility of creating new subsidiaries to take in charge any part of their activities that might conveniently be run on an autonomous basis. This might be done for the provision of VANS (Value-Added Network Services). The 1988 Telecommunications Law indeed stipulates that there should be only one public network - run by PTT Telecom, which is thus the only Dutch PTO (Public Telecommunication Operator), according to the British terminology - but also that PTT Telecom is under the obligation to lease lines as demanded by customers; the prices for these lines are regulated by a public authority (independent of PTT Telecom). Moreover, capacity on leased lines may be resold to third parties; resale is legally restricted to VANS, but this clause seems to be liberally interpreted. The Dutch have thus set their own way of separating a monopoly component in the telecommunications industry from activities where they see competition as desirable for efficiency. PTT Telecom, a company under private status but public ownership, is in charge of the monopoly component

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in telecommunications

The Dutch way.

The Commission is making four recommendations of the PTT:

concerning the task and functioning

-Granting an exclusive concession to the PTT for the provision of transport services via the telecommunications infrastructure, so that the supervising public authority can swiftly give clear guidelines and define supplementary rules as regards the core functions of the public network. -Putting an end to the monopoly of the PTT as regards users’ apparatus supply, installation and maintenance. -Imposing on the PTT a duty of leasing lines; allowing the resaling of transmission capacity on leased lines for the benefit of new tele-information services. -Shifting responsibility for the regulatory tasks from the PTT to a separate body (RVT) under the authority of the Minister in charge of telecommunications’. jiom Commissie Steenbergen (1985). page 49 These propositions have become the matter of three key articles, Articles 3, 4 and 5, in ‘Wet van 26 Oktober 1988, houdende regels met betrekking tot voorzieningen voor telecommunicatie’ (1988 Telecommunications Law).

and is regulated for that sake. It may also, and indeed does, take part in competitive activities, but only in such ways as will guarantee minimum distortion of competition. The British 1984 Telecommunications Act was more restrictive than the 1988 Dutch Law as regards the resale of leased lines. In this particular matter the British Government had not followed the advice of those economists who were in favour of complete freedom of resale as a means to go beyond the rather limited amount of competition that they expected from the asymmetric duopoly made of British Telecom and Mercury [see Beesley (1981)]. An announcement on June 15, 1989, by the Secretary of State for Trade and Industry, shows that the idea of broadening competition in telecommunication services had now made its way: ‘I therefore intend to issue a licence permitting simple resale of U.K. domestic private circuits as well as other forms of resale, bypass and shared use’ [Department of Trade . &-id Industry (1989, page 3)]. This decision might quickly have important practical consequences, some of them surprising at first sight. For example, while some people think that British Rail should concentrate on running rail services in the U.K., it seems that British Rail is seriously considering the possibility of becoming a new PTO (see BR plans to set up its own telephone network). If this actually happens and proves profitable, will British Rail want to invest the profits in the rail business; and will the government encourage BR to do so? All countries in Western Europe are now facing the problem of how to

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BR plans to set up its own public telepbow network. ‘British Rail may be operating its own public payphone service by the end of next year and be installing telephones in many more trains. The public payphone idea is a ‘great possiblilty”, according to Peter Borer, BR’s recently appointed director of commercial telecommunications. The plan is at an early stage but BR envisages that it could promote its corporate images, such as InterCity and Network Southeast. But this is just the thin end of the wedge as BR hopes to cash in on the next wave of liberalisation in the U.K. telecommunications market. BR hopes to eventually be offering private communications circuits for people near its railway network and acting as the backbone link for the plethora of local telephone networks which the Government hopes will spring up all over the country. British Rail has strips of land totalling 17,000 kilometres running into every city centre in the country, and 2,OOOkmof fibre optic cables which form the basis of its own private communications network. The network supports 61,000 telephone extensions and new cable is being installed at a rate of 500 km per year’. from The Independent,

IS August, 1989

make the most of competition in telecommunication services while taking into account natural monopoly aspects and various social and political concerns [see Foreman-Peck and Miiller (1988), Curien and Gensollen (1989) and Padoa-Schioppa (19&J)]. The way the problem is dealt with varies with national traditions, institutions and priorities. One may compare for example the German perspective in Concept of the Federal Gouernment for the restructuring of the telecommunications market, with the British and Dutch ones, that are themselves far from identical. But nowhere, so it seems, can the problem be ignored and its economic meaning be misunderstood. Speaking of national perspectives might be correct to a certain extent. But one should not ignore the diversity of situations within each country. For example, the British Government in 1984 chose to license two PTO’s, and two only. Prior to the 1984 Telecommunications Act, BT (British Telecom) was a public monopoly, and the Act provided for its privatization as a whole. However it was no longer the only PTO to operate in Britain. Mercury Communications Ltd - a subsidiary of Cable and Wireless obtained a first license in 1982, and was licensed as the second British PTO under the 1984 Telecommunications Act. BT and Mercury are thus competitors for the transmission of voice, data, VANS . . . They are very unequal competitors. BT is a huge company, that has inherited the British telecommunications network as it existed at the beginning of the eighties. Mercury has just started to build its own network, linking major British and overseas business centres. Mercury hopes to grow fast enough so to service five percent of the British market by 1990. On the links it serves, Mercury can offer business users better services at more attractive prices. But it cannot reach most telephone subscribers as

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for market.

‘The Federal Government has explicitly decided to pursue a more moderate policy that [...I will not go as far as the models in Japan, Great Britain and the U.S.A. The Deutsche Bundespost will in principle retain the monopoly over the network. A reorganization of the Deutsche Bundespost in the form of a private-law company is precluded by the political majority opinion and the provisions of the German constitution. However, the introduction of efftcient competition in the fields of terminal equipment, innovative services, and in certain fringe areas of the network is an absolutely necessary, politically reasonable and far-sighted measure to avoid that the Federal Republic of Germany will be isolated on the telecommunications markets. Such an isolation would lead to disadvantages for the national economy in the long run as compared to othr leading economies’. from Federal Minister of Posts and Telecommunications

(1988). page 29.

long as its predominantly long-distance network is not connected io BT local networks. In order to deal with this problem, the 1984 Telecommunications Act has set two basic principles: (i) the ‘any-to-any* principle, according to which any subscriber to one network should be able to call any subscriber to the other network; (ii) the ‘customer choice’ principle, according to which any subscriber making a long-distance call should be able to decide on which longdistance network the call is to be routed. But the Act is not clear about how the prices that Mercury would pay to have access to BT local networks should be set. BT has an incentive to use its monopoly power in local networks to distort competition in the longdistance market. As could be expected, BT and Mercury could not reach an agreement. Then, under the provisions of the Act, the Director General of Telecommunication’s had to settle the matter. He was urged by economists, both inside and outside OFTEL, to make a decision aimed at helping competition emerge in the telecommunications industry. Models like those in Vickers and Yarrow (1988)’ point to the desirability of granting the dependent competitor favourable interconnection conditions. The ruling issued in October 1985 by the Director General of Telecommunications is written in legal language; it makes no reference to any model. But the direction taken is clear, as Beesley and Laidlaw (1986) show in their in-depth ‘Exposition and Commentary’ of the ruling: ‘For Mercury to have a competitive opportunity, the payment to BT for interconnecting calls should allow enough margin to linance development and required profits. In practice, the payment to BT ought, in Mercury’s eyes, to be low enough to allow Mercury to offer its customers a discount on its tariff relative to BT’s ‘Pages 7 1-75.

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Transportation: The Swedish way. ‘A fundamental

point in the suggestions we are presenting is the following: The production itself of the various public transport services should be provided by different competing firms whereas the decisions pertaining to the availability of the services should be taken at a central level.

[...I A national public authority should be responsible for all transport national interest, as well as for the availability of the corresponding regional public authorities should bear the same responsibilities at the builders of infrastructure and the tirms producing transport services contracts with the relevant authorities’.

infrastructures of services, whereas regional fevei. The would tender for

from Bohm, P. (1974) ‘The most substantial and long-term element in our transport policy concerns investments. It is the Government’s view that the main responsibility for transport installations for the needs of the public should be under state management. Decisions relating to investments and responsibility for the infrastructure should as a matter of principle be kept separate, from an organizational point of view, from decisions about the production of transport services. As regards production of transportation, effective competition pliers and systems of transport must be promoted.

between different sup-

c. ’ .I The central government and local authorities should be able to purchase transport services that are necessary for reasons of regional policy or to guarantee a basic range of services’. from Ministry of Transport and Communications

(1988). pages 5 and 7.

tariff. Mercury’s delighted response to the determination would seem to indicate that the Director General’s ruling on payments was consistent with Mercury’s approach’ (page 18). In his First Report (OFTEL 1985) to the Government - a document that is not constrained to legal language - the Director General of Telecommunications had written: ‘I attach a high priority to my duty to promote effective competition’ (page 8). His ruling on the BT/Mercury interconnection seems up to this statement, as well as to the expectations of those economists who had been involved. When dealing with large communication or energy systems, it is indeed of great importance to see that the institutions in charge of the natural monopoly components of a system are properly regulated and, in particular, do not distort competition within the components that may best be run competitively; it is also essential to see that the latter are actually competitively run. Nevertheless this is not the beginning and end, a and o; there is more to be dealt with in such complex systems, and more economic analysis can shed light on. The Swedish State Railways have recently been split so that

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different institutions and firms are now responsible for the infrastructure and for the provision of various services. This is indeed an important reform, but the scope of the law of which this reform is part, as well as the range of economic ideas in which the law has matured, are broader (see Transportation: The Swedish way.) They aim at an integrated management of various public goods, publicly provided or publicly supported private goods, and commercial goods, with all transportation modes considered jointly. No doubt that the Swedish way is more inclined towards public ownership and public management, whereas the British way is more inclined towards private ownership and management. In the future, it might look desirable, for efficiency or other reasons, to somewhat tip the balance in favour of the private sector in Sweden, and in favour of the public sector in Britain. Because its approach is more coordinated and because it seems less ideologically entrenched as regards ownership, Sweden - the same is probably true of the Netherlands - might enjoy more flexibility to make the adjustments that might be suggested by further economic analysis. 5. Conclusion

Is the evidence presented in the preceding sections enough to show that David Henderson, in his 1985 BBC lectures, went too far when contrasting micro- and macroeconomics: ‘Why is it’, he said, ‘that in some areas of policy the ideas of economists have little persuasive power. while in others it seems that - to quote again the striking phrase that Keynes used half a century ago - “the world is ruled by little else”? There is no denying that the interactions between microeconomic analysis and the sort of public policies we have considered in this lecture are still limited, almost nonexistent in some European countries. But a recent and significant increase is observed, specially as regards the role of prices in allocation policies and the design of incentive mechanisms. For almost seventy years, Pigou’s results about external effects have been sleeping beauties - I borrow the expression from P. Bohm and A. Sandmo. It seems that they are awakening. This is good news, but long overdue. In other matters, regulation for example, time lags have been rather shorter, although some basic ideas are older than is sometimes believed. As a very last point, I would like to stress the European dimension of the developments I have discussed. The high speed train network will be European; the present assessment efforts already are. All European countries suffer from various forms of pollution; to deal with this situation, a common trend seems to emerge towards more economically-oriented approaches. European countries have somewhat different views about how to reform public services like post, telephone, rail, . . .; but most of them now think in terms of making good use of competition where it is feasible, and aiming at

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both efficiency and neutrality as regards the natural monopoly components. The acceleration of the EEC integration process itself illustrates how economic models may interact with the launching of far-reaching changes in Europe, as Emerson (1988) shows in his paper ‘1992 as Economic News’. But this is beyond my brief, and could be the subject matter of another lecture on microeconomics and public decision making.

References Amason, R., 1989, Iceland’s experience with vessel quotas (University of Iceland, Reykjavik). Beesley, M., 1981, Liberalisation of the use of British Telecommunications network (Department of Trade and Industry, London). Beesley, M. and B. Laidlaw, 1986, The British Telecom/Mercury interconnect determination: An exposition and commentary (Spicer and Pegler Associates, London). Bohm. P., 1974, Transportpolitiken och samhlllsekonomin (Liber F&lag, Stockholm). Bovy, P., 1983, Rapport de l’expcrt charge du reexamen de la route N9 (Ecole Polytechnique Federale, Lausanne). Chassagne, M.E., C. Henry and V. Renard, 1984, Physical planning and equity among landowners: Some cases in France in: F.R. Steiner and H.N. van Lier, eds., Land conservation and development, pp. 273-293 (Elsevier, Amsterdam) Commissie Steenbergen, 1985, Signalen voor straks: Een nieuwe richting voor de PTT (Ministerie van Verkcer en Waterstaat, Den Haag). Commission Biel, 1981, Rapport Iinal de la commission chargte du r&examen de troncons de routes nationales (Office Federal des Routes, Berne). Communauti des Chemins de fer Europeens, 1988, Proposition pour un reseau europr?en a grande vitesse (Union Internationale des Chemins de fer, Paris). Curien, N. and M. Gensollen, 1989, L’ouverture des reseaux: Planification ou concurrence dans les telecommunications et d’autres services publics (Ecole Nationale de la Statistique et de fAdministration Economique et France Telecom, Paris). Dankers, N.. 1978, De ecologische gevolgen van Havenaanleg op het Balgzand (Ryksinstituut voor Natuurbeheer, Arnhem). Deleau, M., 1987, Modelisation Conomique et decisions publiques: Quelques enseignements de l’experience francaise in: Research and Decision-Making in Economics, Management and Engineering (CORE, Louvain-la-Neuve). Department of Energy, 1988, Privatising electricity: The Government’s proposals for the privatisation of the electricity supply industry in England and Wales (White Paper, HMSO, London). Department of Trade and Industry, 1989, Lord Young announces liberalisation of telecommunications, Press Notice 89/437, 15 June 1989, London. Direction de la Prevision, 1987, Remarque sur le choix du project de train a grande vitesse vers le Nord (Ministere de I’Economie et des Finances, Paris). The Economist, 1989, Electricity privatisation in Britain: Competition crushed? 25 February-3 March, London. Emerson, M., 1988, 1992 as Economic News, Economic evaluation of economic policies (Commission of the European Communities, Brussels). Ery, V. and K.T. Forgas, 1987, Environmental protection in a bargaining society (Hungarian Academy of Sciences, Budapest). Escribano, C., 1988, Elaboration de un modelo mecanizado de imputation de castes para RENFE (Red National de 10s Ferrocarriles Espaiioles) (Autonometrics, Madrid). Faulhaber, G. and WJ. Baumol, 1988, Economists as innovators: Practical products of theoretical research, Journal of Economic Literature 26. 577-600. Federal Minister of Posts and Telecommunications, 1988, Reform of the postal and telecommunications system in the Federal Republic of Germany: Concept of the Federal Government for the restructuring of the telecommunications market (R.v. Decker’s Verlag, Heidelberg).

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Foreman-Peck, J. and J. Miiller, 1988, European telecommunication organisations (Nomos Verlaggesellschaft, Baden-Baden). Gemeinsame Deutsch-Franziisische Arbeitsgruppe, 1989, Schnellbahnverbindung ParisOstfrankreich-Siidwestdeutschland (Bericht, Bonn-Paris). Grandiean, A. and C. Henry, 1984, Economic rationality in the development of a motorway network, Transport Reviews 4, 143-156. Hannesson. R.. 1989. Catch Quotas and the variability of allowable catch. in: P.A. Neher et al. (eds). Rights based fishing, pp. 459-465 (Kluwer Academic Publishers; Amsterdam). Helm, D., J. Kay and D. Thompson (eds). 1989, The market for energy (Clarendon Press, Oxford). Henderson, D., 1985, Innocence and design: The influence of economic ideas on policy (Basil Blackwell, Oxford). Henry, C., 1974, Investment decisions under uncertainty: The irreversibility effect, American Economic Review 64, 10061012. Jaffer, SM. and D. Thompson, 1986, Deregulating express coaches: A reassessment, Fiscal Studies 7, no. 4, 45-68. Leitch Committee, 1977, Report of the Advisory committee on trunk road assessment (HMSO, London). Ministry of Transport and Communications, 1988, Government bill on transport policy for the 199Os, English summary (Tralikpolitiken Infhr, Stockholm). Nederlands Economisch Instituut en Rijksinstituut voor Natuurbeheer, 1978, Een haven op het Balgzand (Rapport, Rotterdam en Arnhem). Newbery, D.M., 1989, Cost recovery from optimally designed roads, Economica 56, 165-185. OECD, 1989, Economic instruments for environmental protection (OECD Environment Monographs, Paris). OFIEL, 1985, First report (HMSO, London). Padoa-Schioppa, F., 1988, Strategic et Techniche d’lntervento, Sintesi dei resultati del Sottoprogetto 3, Progetto finalizzato Struttura ed Evoluxione dell’Economia Italiana (Consiglio Nazionale defie Ricerche, Milano). Pearce. D.. 1989. The imolications of sustainable development for resources accounting, project appraisal and integrative environmental policy, A report by the London Envir&tmental Economics Centre for the U.K. Department of the Environment. So&P Nationale dcs Chemins de fer Francais, 1986, Projet de desserte du Nord-Ouest de I’Europe par trains a grande vitesse (Rapport, Paris). H.M. Treasury, annual, Investment appraisal in the public sector: A technical guide for government departments (HMSO, London). Vickers, J. and G. Yarrow, 1988, Privatisation: An economic analysis (MIT Press, Cambridge, MA). Walras, L., 1877, L’Etat et les chemins de fer, reproduit dans Elements d’economie politique appliqde, translated by P. Holmes in Journal of Public Economics 13, 81-100.