Freight

An Evaluation of the Draft Access Pricing Principles for Access to the Victorian Rail Network (Freight) A Report Prepared on Behalf of Freight Australia Ltd

by

Joshua S. Gans University of Melbourne

28 th June, 2000

Executive Summary This paper evaluates the proposed access pricing arrangements for the Victorian rail network. Those arrangements are a form of average cost pricing but without any allowance for assets already in existence. In terms of efficiency, while such pricing can promote downstream competition it is likely to create allocative, productive and, most importantly, dynamic inefficiencies that will likely outweigh any overall competitive benefit. In particular, • Simple average cost pricing per gross tonne km is likely to give rise to allocative inefficiencies because it takes no account of demand-side information or the technological characteristics determining the relationship between costs and weight multiplied by distance. The end result will be that the rail network is inefficiently utilised with consumers with relatively elastic demand not gaining sufficiently from increased competitive pressure perhaps to the extent of facing higher rather than lower prices. • The proposed access pricing arrangement is unlikely to achieve long-term productive efficiency especially to the extent that it is successful in placing large downstream competitive pressure on the incumbent rail operator. This is because the pricing mechanism is purely cost-based offering few transparent incentives for the network operator to direct efforts toward cost-reduction. • The proposed access-pricing regime for the Victorian rail network is likely to be highly inefficient from a dynamic perspective. It provides incentives for distortionary expenditures on new capital while sending a signal to potential infrastructure operators in Victoria that they will be unlikely to earn rates of return commensurate with the social value of those investments. Given such regulatory risks, new infrastructure investment and the purchase or lease of privatised assets in Victoria are likely to be delayed and potentially curtailed altogether. It is demonstrated that such access pricing is not practiced for rail in Australia or in other countries. Based on experience elsewhere and on economic theories of efficient access pricing, it is concluded that a preferred pricing outcome would be to impose a multi-part tariff with: •

Usage charges that reflect an appropriate unit of the service, likely to be contingent on the type of freight, as well as be a price cap rather than a cost-plus price.

•

A fixed charge that is designed so as to facilitate the efficient recovery of investment costs utilising demand-side information to reflect a downstream

access seeker’s value on access as well as incentives to prevent by-pass or cream skimming. In this way, a transparent pricing commitment could be made by the regulators to facilitate negotiations over access while preserving overall economic efficiency.

Contents

Page

1

Background.............................................................................2

2

Efficiency Implications of Proposed Access Pricing Regime......................................................................................4

3

4

2.1

Allocative Efficiency...................................................... 6

2.2

Productive Efficiency ....................................................11

2.3

Dynamic Efficiency.......................................................13

2.4

Negotiations..................................................................19

Other Rail Access Pricing Regimes ..................................21 3.1

Australia........................................................................21

3.2

International..................................................................23

Towards a More Efficient Pricing Structure ...................24 4.1

Taking into Account Investment Costs ........................24

4.2

Incentives for Cost Reduction.......................................26

4.3

Consistency and Transparency.....................................27

5

Conclusions ...........................................................................28

6

Tables: Approaches to Freight Rail Access Pricing .......29 6.1

Australian Approaches .................................................29

6.2

International Approaches .............................................30

Attachment A: Recent Research....................................................32 Attachment B: Consultant Profile.................................................34

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1

Background

In April, 2000, the Victorian Government proposed to declare the Victorian rail network used for freight purposes. This would give potential access seekers – people or firms wishing to haul freight on the rail network – the right to gain access on terms that would be negotiated between those seekers and Freight Australia, who currently leases the rail network from the Director of Public Transport.1 This proposed declaration will arise under Part 2A of the Rail Corporations Act 1996. That Act gives the Office of the Regulator-General (ORG) the role of arbiter in any disputes between Freight Australia and access seekers. As part of the declaration process both the ORG and the Victorian Department of Infrastructure have issued draft access pricing guidelines that will form that basis of arbitrated outcomes.2 The key characteristics of the proposed pricing regime are: • Simple pricing per gross-tonne-kilometre used by the access seeker (including a flagfall charge); • Price is based on a measure of variable costs for a line, that is, operations and maintenance costs (plus a 10% margin), plus new capital expenditure associated with that line and a rate of return on that new expenditure; • Adjustments are made to the cost-base where passenger services also run on a line. In particular, on the metropolitan network which is primarily passenger based, freight operators will be responsible for incremental costs only (except for peak periods). On the country-network, account will be made for passenger traffic although a disproportionate share of all costs will fall on

1

2

Who in turn has leased it from VicTrack (a Victorian government statutory authority).

“Proposals for Implementation of the Victorian Rail Access Regime,” Department of Infrastructure, Victoria, April 2000 and “Victorian Rail Access Regulation – Discussion Paper,” Office of the RegulatorGeneral, Victoria, 19 April 2000.

Section 1

Background

freight traffic even though passenger traffic will receive scheduling priority. An important feature of this proposed pricing regime is that there is no allowance for previous investments in the rail network. These costs were considered ‘sunk’ and hence, the government was of the view that no rate of return would be required on these. This included any rental payments for the operation of that network. However, this principle was not applied for the Dynon terminals where existing assets could be included in the cost-base; including a factor for a rate of return earned by the access provider. Because charges are based on a ‘line service,’ some common costs incurred over the entire network will have to be allocated to a line. However, despite the desire for transparency and simplicity, no means of allocating those costs is given in the guidelines save for the requirement that such an allocation be “fair and reasonable.”3 This paper will review the proposed access pricing approach for the Victorian rail network. The next section discusses the implications of the proposed approach for the realisation of economic efficiency and demonstrates that it is likely to fall short of goals attained for regulators in other jurisdictions. Section 3 will then compare the proposed approach to rail access regimes in other jurisdictions; finding the proposed approach unique in its lack of attention to investment incentives and incentives for cost-reduction. Section 4 will then propose some potential changes to the proposed regime that would likely result in substantial efficiency improvements. A final section concludes.

3

DOI, op.cit., p.51.

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2

Efficiency Implications of Proposed Access Pricing Regime

Efficiency Implications of Proposed Access Pricing Regime

Access regulation is a response to a particular competitive concern that pervades many industries where infrastructure investment is heavy. In effect, many networks – rail included – involve production technologies that exhibit natural monopoly characteristics. This means that, from the point of view of minimising the average production costs associated with that networks’ services, it is preferable to have one, and only one, network. Any more and the infrastructure costs associated with that network are duplicated; imposing real resource costs on the economy. The problem, however, is that where there exists a single network, there also exists a single seller of network services and consequent problems associated with monopoly supply. The potential problems of monopoly supply are threefold: • High prices: the prices charged by a monopolist for services rendered may be too high and create so-called ‘dead-weight losses.’ These losses arise because there are consumers who would be willing to purchase an extra unit of the service at a price that exceeds the costs associated with supplying that extra unit to them. Value would be enhanced if that trade took place but the monopolist, fearful of discounts to other customers, chooses not to lower price and expand output. The possibility of price discrimination can alleviate this problem but may exacerbate other problems associated with monopoly. • Cost and quality: in the absence of competitive pressure there is concern that a monopolist may have insufficient incentives to invest in cost-reduction or quality-enhancement. Of course, to the extent that the monopolist can appropriate cost savings or quality enhancements in the form of higher profits such concerns are perhaps unfounded. Nonetheless, it is generally thought that the absence of competitive pressure may lead to higher costs and lower quality than would be socially desirable.

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• Vertical leverage: the final problem of monopoly is the ability of the monopolist to use its market power to generate monopoly outcomes in related markets; in particular, for a network, there is a concern that the monopolist may use discriminatory pricing or vertical integration to reduce the level of competition in downstream markets. Access regulation is, in the first instance, a means of addressing the final problem here. That is, it guarantees access of downstream firms to the use of the services of the network and also ensures that the pricing terms are such as to preserve downstream competition. This prevents the leverage of monopoly power to other markets. However, from the perspective of overall efficiency, appropriate access regulation also plays a role in reducing the efficiency losses associated with high monopoly pricing and also ensuring that the cost and quality of network services are acceptable. Of course, in evaluating the potential efficiency of access regulation one also needs to be concerned about its impact on the network’s decisions on variables that are not directly regulated. In the case of a rail network key unregulated variables include the downstream pricing of the vertically integrated rail operator as well as its decisions regarding new investment, effort in cost-reduction and the quality of its service. These variables either cannot be easily regulated or the informational burden on regulators in ‘second-guessing’ the commercial decisions of a private firm is too high. Indeed, the economic rationale for privatisation (or in this case private control) of such networks lies predominantly in the fact that efficiency would be enhanced if such variables were unregulated and, but for some minimal requirements, determined by the profit-seeking opportunity of the private owners. If those efficiencies were not expected then perhaps it would be better to ‘regulate’ such networks by leaving them in public hands without the profit-orientated incentives that would otherwise direct their activities.4 Thus, access pricing cannot simply be determined with respect to theoretically desirable pricing benchmarks as the precise means of regulation may influence the network’s choices on other fronts. Those

4

Stephen King and Rohan Pitchford, “Privatisation in Australia: Understanding the Incentives in Public and Private Firms,” Australian Economic Review, 31 (4), 1998, pp.313-328.

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choices may impose additional efficiency costs on the industry. Consequently, appropriate access regulation will take into account the incentives provided on other variables under the control of the network and adjust access pricing formulae accordingly. From this perspective, one needs to evaluate a proposed access pricing arrangement in terms of the overall achievement of economic efficiency. Such efficiency can be divided into three components: • Allocative Efficiency: the network’s assets should be used efficiently. That is, where there exists a use for service for which the incremental costs of that use are lower (higher) than the value placed on that use by a network’s customer, the service should (should not) be supplied to that customer. • Productive Efficiency: the network should operate at the lowest possible average cost. • Dynamic Efficiency: improvements or expansion of the network should only take place if the long-run value derived from those investments exceeds the costs associated with that investment. The proposed access pricing arrangement should be evaluated with respect to the achievement (or non-achievement) of each of these efficiency improvements. Each is dealt with in turn.

2.1

Allocative Efficiency

One of the goals of access regulation is to ensure that infrastructure is put to its optimal use. This means that services are sold to customers who value that service more than the marginal or incremental costs of supplying that service to them. On the other hand, where marginal costs outstrip a customer’s willingness-to-pay for the service, the service should not be supplied to them. In economics, the textbook pricing benchmark – that of setting price equal to short-run marginal or incremental cost – is designed to achieve optimal usage of a service. When price equals short-run marginal cost, customers will only purchase that service if their willingness-to-pay

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exceeds that and not otherwise. What this means is that, in general, if price does not equal short-run marginal cost, there will be losses in allocative efficiency. For high prices, too few customers are supplied the service and for low prices, too many. The latter can occur when there is some form of subsidy to the service. The proposed pricing arrangement for Victoria rail differs from this pricing benchmark in two important ways. First, it is based on a form of average, rather than marginal, cost pricing. Second, it is a charge based on gross tonne kilometres that may not accurately reflect a ‘unit’ of freight rail service. As will now be shown the neglect of each of these makes it likely that outcomes achieved will be allocatively inefficient resulting in sub-optimal usage of the network. 2.1.1

Average Cost Pricing

The incremental cost of supplying a service to a customer involves those costs that would be avoided or saved if the service was not supplied. This includes additional labour and energy devoted to servicing that customer as well as an estimate of the wear and tear (and resulting maintenance) that can be attributed to that customer. In an access situation, also included with these cost would be costs associated with providing access. These might include accounting and contract settlement costs but would also include an allowance for congested track in times of capacity shortages. Including the costs of providing access as part of the cost-base in pricing was not explicitly addressed in the proposed access-pricing regime although it is standard practice in other jurisdictions and one would expect to see it come under the cost allocation procedures. In practice, with many different users of a service, estimating incremental costs involves accounting for all of the variable costs of a service as well as accounting for maintenance on the line and apportioning it to different users based on the intensity of their use of the service. These operations and maintenance costs are included in the costbase in the proposed pricing arrangements. However, additional costs are included in that cost-base. First, the network is allowed to earn a rate of return on operations and maintenance

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costs associated with a line. Second, new capital expenditure plus an allowable rate of return on that also form part of the cost-base of the line. Finally, common rail network costs that cannot be attributed to a given line are allocated to lines on a yet-to-be-defined ‘fair and reasonable’ basis. Each of these means that the price paid by access seekers to use a network will exceed incremental costs. Hence, it may be under-utilised resulting in a loss in allocative efficiency. This is a common difficulty in regulation where it is required that a rail network be allowed to break even. That is, new capital expenditure and common costs need to be recovered by the access provider. This means that some of these costs must be recovered from access seekers; otherwise the provider would not break-even and could even shutdown. Hence, allowing for the recovery of those costs will invariably mean that per unit prices will exceed incremental costs.5 The problem, however, is that average cost pricing is a highly inefficient way of recovering fixed costs associated with production. This can be seen by observing the way a vertically integrated rail operator chooses to price to freight haulers. It is invariably the case that different customers pay differing rates depending on the type of freight hauled and potentially on the distance hauled. In its pricing, the rail operator takes into account the differing elasticities of demand for the rail service among customers. A customer that relies exclusively on rail will have a higher elasticity of demand relative to one that has the option of other modes of transport (including road or sea). For example, compare bulk traffic to containerised traffic. Hence, by charging the relatively inelastic customer a higher price, the rail operator assists in raising profits; giving it a greater opportunity to recover its fixed costs. It does this precisely because a high price to the relatively inelastic customer will not cause it to reduce its use of the rail services by as much as for the relatively elastic customer. In other words, price discrimination allows the rail operator to increase profits at the least distortion to allocative efficiency. Similarly, the same principle should apply for the efficient recovery of fixed costs in regulated pricing. That is, the least distortionary means of

5

As will be discussed in Section 4 below this need not occur if the regulator encourages the use of non-linear pricing such as a two-part tariff.

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allowing a regulated network to break-even is to price discriminate among customers. This is the so-called Ramsey logic for regulated pricing.6 It is a relatively efficient means of regulated pricing because it utilises demand-side information in addition to basing prices ultimately on incremental costs. The proposed pricing regime based on average cost pricing is likely to be highly inefficient precisely because it neglects any demand-side considerations that have proven to be very important in rail service pricing. What this means for the operation of the network is that access seekers will have an opportunity to engage in ‘cherry picking’ or ‘cream skimming.’7 That is, when they face access charges based on average costs only, they will find it profitable to service those customers that would be otherwise charged a high price by the vertically integrated rail operator. This competition will reduce the price received by relatively inelastic customers who are dependent on rail services. This is obviously desirable for those customers. However, it is also likely to raise the prices faced by relatively elastic customers. This is because the rail operator’s incremental cost of servicing those customers (to the extent that average costs on a line rise with overall use) will rise. Hence, those customers will be worse off and, will be the losers rather than the beneficiaries of competition. However, the distortions associated with neglecting demand-side considerations in pricing go further. In particular, the lack of specification of the allocation of common network costs means that potentially costs will be more likely to be allocated to those lines likely to be subjective to competitive use. In some sense, given the distortions of average cost pricing, this redresses some the cream skimming problems. It does this, however, in a relatively inefficient and potentially damaging way. Moreover, and more seriously, the distortions introduced may be real in nature. The network management may direct their attention towards services they operate with higher margins and away from competitive segments. Once again, if the pricing regime gives incentives for cream

6

See, for example, J-J. Laffont and Jean Tirole, Competition in Telecommunications, MIT Press: Cambridge (MA), 1999. 7

See Alfred Kahn, The Economics of Regulation: Principles of Institutions, vol. 2, New York: Wiley, 1971; and J.-J. Laffont and Jean Tirole, The Theory of Incentives in Regulation and Procurement, MIT Press; Cambridge (MA), 1993.

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Efficiency Implications of Proposed Access Pricing Regime

skimming, one can expect the regulated network to use its accounting and other choices to minimise that harm. 2.1.2

‘Unit’ of the Service

The proposed access price is based on a per gross tonne kilometre basis. Effectively, this means that a unit of the access service is weight multiplied by distance. However, it is not entirely clear that the costs associated with providing this service relate to this simple service measure. This is, by definition, the case for fixed costs included but also applies to variable costs where maintenance is more likely to depend on weight compared with operations. However, both classes of costs are treated equally. The definition of a service is, of course, a difficult one. It may be that for certain types of freight a gross tonne km basis is the best measure available. However, one should look to the business practices of rail operators in their pricing to final consumers to determine this. Here one would likely find that the terms of offered to those consumers are highly contingent on the type of traffic and distance travelled.8 In particular, the overall price is not necessarily a simple, linear function of weight multiplied by distance. What this means is that if the unit for the access service differs from that that would be appropriate to measure costs associated with that service, further distortions are introduced. In particular, if as weight increases, marginal maintenance costs rise, then access seekers will be able to more easily attract ‘heavy’ haulage and a disproportionate share of costs will end up being passed onto ‘light’ haulage. If marginal maintenance costs are falling as weight rises, the opposite could occur. This suggests that the regulators need to be very careful before specifying a particular ‘unit’ of the service. As we will see in Section 3, gross tonne km is not used as the basis for access pricing in all jurisdictions.

8

Indeed, these tensions are already apparent in the proposed access regime which changes the ‘unit’ for those lines that operate passenger traffic.

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2.1.3

Efficiency Implications of Proposed Access Pricing Regime

Summary Simple average cost pricing per gross tonne km is likely to give rise to allocative inefficiencies because it takes no account of demand-side information or the technological characteristics determining the relationship between costs and weight multiplied by distance. The end result will be that the rail network is inefficiently utilised with consumers with relatively elastic demand not gaining sufficiently from increased competitive pressure perhaps to the extent of facing higher rather than lower prices.

2.2

Productive Efficiency

Particular forms of regulation can influence other variables under the control of the regulated firm. One class of variables concerns the efforts of the operators of a network towards ensuring the costs are as low as possible and quality is maintained. However, the regulated price here is exclusively cost-based. From an economist’s perspective this means that the regulated firm will have low-powered incentives to contain costs and maintain quality. Indeed, under the proposed access-pricing regime, the more successful are potential entrants into its downstream activities the lower will be its incentives to undertake these activities in a socially desirable manner. The end-result will be that the rail network in Victoria will be productively inefficient as costs will not be minimised and quality may deteriorate. As mentioned earlier, this would undermine the precise benefits privatisation was designed to generate. There are two dimensions of the incentive problem that arises when a cost-based pricing scheme is used: cost-reductions and cost reporting. First, consider the case where the regulator can accurately determine what the true costs are that form the basis of the price. In this situation, every $1 achieved in cost reduction results in a $1 reduction in price. Thus, the regulated firm’s incentive to engage in that cost reduction relates not to the total level of rail traffic on a line (say Q) but only its own proportion of that (say q). Thus, to the extent there are investments to achieve that reduction in cost, the network’s reward for that reduction is at best q for each dollar saved and may be worse if the reduction

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precipitates a more than proportionate increase in price competition downstream.9 What this means is that the network operators incentives to contain costs are lowest precisely on those lines that are subject to the most competition and third-party access. Indeed, it is possible that costs may be lower and fewer distortions may actually occur if there was no access regulation. Thus, a lack of respective for incentives has the potential to undermine the very gains, in terms of lower final service prices, that access regulation was designed to promote. Second, to the extent that the regulator cannot easily establish the costs of the network, there is potential for a distortion of reported costs upward. This has the harmful consequence of raising access prices and potentially undermining the strength of downstream competition. However, to the extent that it is easy to engage in ‘creative accounting,’ this does mean that the network will retain a greater share of actual cost savings; thereby, mitigating some of the adverse incentive consequences described above. At present, the proposed guidelines do allow for some monitoring of costs but ultimately establishing actual costs will require an adequate level of regulatory resources; imposing more real economic costs. As will be discussed in Section 4, concerns about the incentive effects of cost-based regulated prices have caused regulators in many jurisdictions and industries to move towards pricing mechanisms with more preferable incentive properties. A final consideration with respect to productive efficiency concerns the lack of incentives given in the proposed pricing arrangements to access seekers to ensure that their own wagons and traffic are operated and maintained in a way that minimises wear and tear on the rail track itself. While access arrangements can have minimal standards for access to be granted, the pricing arrangements offer no means by which the network operator can reward access seekers for car quality beyond these minimal levels. Once again, the neglect of this is likely to exacerbate cost and quality concerns and further damage the productive efficiency of the rail industry in Victoria.

9

Indeed, the rate of return allowed on all these costs – being a percentage of these costs – distorts incentives away from cost-reduction and cost reporting even further.

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Efficiency Implications of Proposed Access Pricing Regime

The proposed access pricing arrangement is unlikely to achieve long-term productive efficiency especially to the extent that it is successful in placing large downstream competitive pressure on the incumbent rail operator. This is because the pricing mechanism is purely cost-based offering few transparent incentives for the network operator to direct efforts toward cost-reduction.

2.3

Dynamic Efficiency

Perhaps the most important dimension of efficiency concerns the impacts of the access-pricing regime on long-term incentives to invest in new infrastructure. One of principal motivations for privatisation of public utilities was to allow private market forces to determine new investment decisions. Hence, in evaluating the impact of access regulation on the rail network it is critical to consider what its impact will be on new capital expenditure for that network but also on the signal it sends regarding regulatory attitudes towards investment across all infrastructure industries in Victoria. 2.3.1

New Rail Investment

New rail investment will be best undertaken when the value of improved service – relief of congestion, long-term quality enhancements etc. – exceed the investment costs associated with those improvements. In an access context, value should be evaluated in terms of value to the access provider and to access seekers. The proposed access regime makes allowances for new investment and, indeed, will allow adjustments to the access price when such investment takes place. This includes both line specific investment, whose expenditures will be allocated through the cost-base of the access price and network expenditures that will also be allocated in part to particular lines; forming part of their cost-base. The problem with this method of treating new investment is precisely the same as the problem with the way all costs are dealt with through the proposed pricing regime: they provide low-powered incentives for the network to contain new capital expenditures. In particular, the greater are these, the higher will be access prices and the

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lower will be the degree of downstream competition. Basically, new capital expenditures impose an externality on access seekers through the consequent adjustment to access prices and, as such, will likely mean that such expenditures will be excessive from a social perspective. The source of this difficulty is essentially to cost-based form of access pricing. As will be argued in Section 4, these incentive difficulties could be remedied if the regulator were to opt for a higher-powered incentive scheme as practiced in other jurisdictions. 2.3.2

Investment Signals

The papers proposing the access-pricing regime for freight rail in Victoria give scant attention to the rationale behind the chosen pricing formula. However, the attitude to investment signalling is made very clear by the following statement: Much of the network was constructed decades ago and can be regarded as a “sunk cost” for which no capital return is required…. For the same reason no amount is allocated for rent or other payments made by the Access Provider under its lease.10

As I will discuss here, this statement is incorrect as a matter of economics and represents an extraordinary disregard for the principles of efficient regulation. Basically, by not allowing the access provider to recover sunk infrastructure expenditures through access pricing – leaving the provider to rely solely on their own downstream activities – the regulator is sending a signal to investors in infrastructure that they have a choice of waiting for other potential providers to invest first and seek access from them or alternatively to invest and find the value of assets created expropriated by the Victorian regulator. Almost all investments in infrastructure represent sunk costs, ex post. Basically, the assets are dedicated to particular activities and often have little scrap value. While it is consistent with economic efficiency to neglect these sunk expenditures in determining the optimal use of an asset, regulatory authorities cannot neglect them when it comes to the potential for future investment. No firm would invest if it thought that,

10

DOI, op.cit., p.19.

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after the fact, they would be deemed sunk and no return would be required. No financier would lend to a firm that believed this. All investment takes place with a view to future return and the potential irreversibility of investment decisions is a constraint that requires potential investors to be even more secure in their expectations of generating a return.11 So far from not requiring a return, the requirements are in fact more stringent than for investments that were reversible and whose expenditures were not sunk. In an access setting, the consequences of a lack of respect for investment incentives are profound. Put simply, potential investors would rationally delay or refrain from any investments if they thought investment costs would not form part of the cost-base for access pricing – even where their own return would justify that investment. To see this, consider the following hypothetical situation. [I]magine that the Trade Practices Act mandated that the services provided by all lawncutting devices were subject to an access regime, in this case, for the production of neat gardens. The Smith family is considering purchasing a lawnmower. However, before they do this they notice that their neighbours, the Jones family, have a nice new lawnmower. The Smiths propose to the Joneses that perhaps they could borrow their mower for one day a week. They argue that the loan would not inconvenience the Joneses who use the lawnmower themselves for one day each week. Of course, the Smiths will compensate the Joneses for fuel used and physical depreciation caused. This offer is, of course, consistent with the economically efficient use of the lawnmower. That is, given that the lawnmower exists and is not fully utilised by the Joneses (that is, there is excess capacity), if the Smiths are willing to bear the costs of their usage, it is socially efficient for them to be granted access to the Joneses’ mower. To the extent that there is a legal stipulation for the Joneses to grant the Smiths access, so much the better. The problem, however, is that the Joneses were considering purchasing an electric weeder. They had decided that the purchase would have been worthwhile even if it were only

11

For an explanation see A. Dixit and R. Pindyck, Investment Under Uncertainty, Princeton University Press: Princeton (NJ), 1994.

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used one day a week. At first glance, it would seem that the prospect of renting would only enhance the benefits that the Joneses would derive from purchasing the weeder. However, the Jones family are sophisticated thinkers. They reason that it might be better to see if someone else on the street purchases the weeder first. That household would bear the capital costs of the weeder while the Joneses could simply rent it out for one day a week. Under a proposal such as that of Smith for the mower, Jones would only have to pay for the operating expenses of the weeder – a negligible amount relative to the purchase costs. 12

Access regulation that neglects sunk investment costs creates a free-riding problem among potential investors. Each chooses to delay investment and wait for others to provide the infrastructure; with access regulation freeing them from ever having to contribute to the investment. However, with all investors realising this, no one investor is likely to take the lead. The end result is delayed investment; with only the potential competitive returns motivating investors. If, however, the investment costs are insufficient to cover those competitive returns, investment will never take place.13 So while it is true that for the current rail network in Victoria, the assets already exist and access regulation will not change that; this is not the case for new investment or for assets yet to be privatised. In those situations, investors will look to past regulatory decisions – such as these proposed pricing rules – to inform them about the regulatory environment they will face after the fact. And these proposed pricing rules, by ignoring prior investment altogether, sends the worst possible signal for future investment. The costs in terms of delay and curtailed infrastructure investment are potentially extreme with consequent implications for the rate of economic growth in Victoria. For the current case the neglect of sunk costs is even more perplexing when one recognises that the existing assets are leased rather 12

Joshua S. Gans and Philip Williams “Efficient Investment Pricing Rules and Access Regulation,” Australian Business Law Review, Vol.27, No.4, August, 1999, p.268. See also J S Gans and S P King, “When Being First Doesn’t Pay”, The Australian Financial Review, Friday 30 January 1998, p 32. 13

It is unclear at this stage how re-opened track might be treated. If the assets of those lines – as they already exist – are treated the same as those elsewhere, what is Freight Australia’s incentive to re-open track; especially where it could be subject to competition from access seekers.

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than owned by the access provider, Freight Australia. They were offered a fifteen-year lease of the rail track from the Director of Public Transport with two further renewal options that have already been exercised. Such long-term leases are desirable as they provide Freight Australia with incentives to operate and maintain the track almost as if they owned the track themselves. The long-term lease is also desirable in that effectively allows the lessor and lessee to share risk associated with the long-term value of the rail track. Finally, the upfront payment to the government presumably enabled it to write off debt earlier conferring further benefits on the state. However, consider the situation that would arise if it were known that regulated access prices would exclude those lease payments because the lessee had already paid them. No rational firm would take out more than a very short-term lease; perhaps a year. They would be better off waiting for another firm to take the lease and then free ride off that decision by avoiding having to contribute to the lease payments. Indeed, it is likely that, because the assets exist, no firm would rationally pay for lease at all; operating on the belief that without potential private operators the government would still operate the track and they could receive access to it on terms that would apply to private track operators. The likely end result is that a leasing or privatisation option would be closed for the government; and any benefits resulting from that would be lost. It is for precisely this reason that lease payments on existing assets are not generally considered to be sunk by economists. This is because, if a firm shutdown their activities, they could avoid these costs. For the Freight Australia case, the fact that they have paid for a long-term lease up front may covert lease payments into a sunk expenditure but, from a regulatory perspective, it does not change the principle regarding how lease payments should be considered. For both fairness and also to encourage the optimal incentives for long-term commitments – such as leases and investments – to be made, the fact that payments for half a century were made upfront should not make one treat the payments as if they were to be paid every year for that same period of time.14

14

Such perverse logic could go even further. Suppose that Freight Australia outsourced its maintenance activities to another firm with a long-term contract. Would that then imply that those costs were no sunk rather than on-going? From a regulatory perspective it simply should not matter.

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Section 2

Efficiency Implications of Proposed Access Pricing Regime

To be sure, from Freight Australia’s perspective, the proposed regime does not rule out them earning a rate of return on the assets they have leased. Interestingly, however, the rate of return is likely to be very low if competition downstream is intense. In the extreme, another provider could claim a sizeable market share without contributing at all to the investment costs of the rail network. From this perspective, the incentives to invest are likely to be lowest precisely where access regulation is likely to be the most effective in promoting competition. The neglect of sunk costs in the access-pricing regime creates an environment of uncertainty in Victoria. The proposed pricing regime is not even consistent on this point with regard to other related assets. For example, the sunk capital in the Dynon terminals will be included in the cost-base for pricing for access to those facilities. The reason given is that the “capital costs are involved and because the service provided can be more complex.”15 However, this explanation makes no sense whatsoever. It is not clear to me why the so-called ‘sunk cost’ logic should apply to rail networks but not the terminals. Indeed, it is interesting to compare the treatment of existing assets with new capital expenditures. There, even after these have occurred, the costs associated with new capital can be recovered to some extent through access pricing. However, after the fact, those expenditures will also be sunk. The question is: if it is clear that not including new capital expenditures as part of the cost-base for access pricing would be desirable from the perspective of encouraging those expenditures, why would the same logic not apply to existing assets or leases; the latter that was at least up until last year a new expenditure from the perspective of Freight Australia? The inconsistent treatment of expenditures related to existing assets versus the Dynon terminals and new capital expenditure creates uncertainty with respect to regulatory decision-making and imposes further risks that will likely deter infrastructure investment in Victoria.

15

DOI, op.cit., p.19.

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Section 2

Efficiency Implications of Proposed Access Pricing Regime

The proposed access-pricing regime for the Victorian rail network is likely to be highly inefficient from a dynamic perspective. It provides incentives for distortionary expenditures on new capital while sending a signal to potential infrastructure operators in Victoria that they will be unlikely to earn rates of return commensurate with the social value of those investments. Given such regulatory risks, new infrastructure investment and the purchase or lease of privatised assets in Victoria are likely to be delayed and potentially curtailed altogether.

2.4

Negotiations

The above analysis has implicitly treated the proposed access prices as the access prices that will actually be paid for freight rail in Victoria. However, one has to remember that this is a regime of ‘regulation by negotiation’ and that the proposed access prices will only be implemented in the event that the provider and a potential access seeker fail to reach agreement in access negotiations. The fact of negotiations softens an economist’s conclusions regarding the likely productive and allocative inefficiencies that will result from the access-pricing regime. These inefficiencies create costs for seeker and provider alike and hence, during negotiations they will be ironed out in the interests of maximising mutual profits. However, these inefficiencies are not the only things that could be removed to increase the joint profits of the access provider and access seekers. As King and Maddock note “… firms will negotiate access prices and conditions that suit them, not those which increase social well being …”16 They could also come a pricing arrangement that will soften downstream competition between them and hence, preserve monopolistic profits there. In the extreme the only difference between this scheme and no access regulation

16

Stephen King and Rodney Maddock, Unlocking the Infrastructure: The Reform of Public Utilities in Australia, Allen & Unwin: Sydney, 1996, p.97.

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Section 2

Efficiency Implications of Proposed Access Pricing Regime

is the shift in distribution of monopoly rents from the access provider to access seekers.17 However, it is this very shift in rent distribution that means that the proposed access pricing arrangements are likely to impact negatively on dynamic efficiency regardless of whether they are negotiated or imposed. This is because the neglect of sunk assets diminishes the ability of the access provider to earn a return of return on investments even when it negotiates with seekers. Unless the provider and seekers can come to an arrangement prior to investment taking place that shares such costs, the low investment incentives provided by the neglect of investment costs in the cost-based of the access price carries over. Any such prior agreement is particularly unlikely in access negotiations such as this one. In conclusion, taking into account the possibility of negotiations means that the potential allocative and productive inefficiencies are likely to be less extreme as those discussed above but also that the potential for downstream competition to the benefit of ultimate consumers of freight rail transport are similarly likely to be diminished. What remains, however, are the low investment incentives and consequent dynamic inefficiencies that are likely to be the largest costs imposed by the proposed regulation.

17

For an elaboration of this argument see Stephen P. King and Rodney Maddock, “Light-handed Regulation of Access in Australia: Negotiation with Arbitration,” Information Economics and Policy, 11 (1), 1999, pp.122.

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Section 3

3

Other Rail Access Pricing Regimes

Other Rail Access Pricing Regimes

It is all very well to cite that a proposed access pricing formula will create certain economic inefficiencies. One reason an inefficient pricing rule is used is because of the difficulties or costs of implementing other pricing rules that will relieve some of these adverse consequences. However, the experience of rail access regulation elsewhere demonstrates that other pricing rules are both implementable and are likely to generate more desirable outcomes in terms of allocative, productive and dynamic efficiency than that proposed for Victoria rail. In this section, the alternative rail access prices imposed elsewhere are review while in the next, the potential benefits of those alternatives are considered.

3.1

Australia

There are rail access regimes currently in place in NSW, Western Australia, South Australia and for the NT/SA AustralAsia rail line. They are summarised in Table 6.1 in the Appendix to this report. Each of these adopts a floor/ceiling approach; although for the AustralAsia rail line a competitive imputation rule is used where effective inter-modal competition exists for a particular type of freight. The floor/ceiling approach sets the bounds on access prices that can be negotiated between rail access providers and seekers. The floor on the price allows the provider to recover the incremental costs associated with providing the rail service to the provider; although in the NSW case these costs do not necessarily include common network costs allocated to a line. In effect, this means that the access provider cannot be required to subsidise an access seeker. On the other hand, the ceiling is designed to reflect the stand-alone costs of a particular line. In other words, the access seeker cannot be charged a price greater than that that would justify them reconstructing the line and by-passing the existing network. This is an appropriate ceiling that avoids inefficient investment by potential seekers in rail

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Section 3

Other Rail Access Pricing Regimes

infrastructure. Notice that to achieve this the ceiling must include an allocation for sunk investment expenditures; usually implemented on asset valuations at replacement cost to take into account falling rail investment costs that might arise form technological progress. Once again, a replacement value approach is consistent with the rationale of avoiding theoretical by-pass. Effectively, the floor/ceiling approach constrains the access prices to avoid cross-subsidisation of particular lines and also the extraction of unreasonable monopoly rents from a particular seeker. Negotiated outcomes will likely lie between these extremes. Hence, those outcomes could take into account demand-side information and also provide for incentives for productive efficiency and the like while allowing the provider to earn a rate of return on existing assets. In Victoria, the floor/ceiling approach was seen as “inappropriate.” Many lines are only lightly used, so costs vary with time (e.g., weathering, weed control, clearing drains) rather than with use; the variable cost caused by extra trains is minimal. The gap between the floor (variable cost) and ceiling (stand alone cost) would be large, so the approach would provide little guide to pricing. Differences in ability to pay would be difficult to determine given the nature of rail freight in Victoria (grain and other commodities, but little coal or minerals). It was considered that the interests of all parties (the Access provider and access seekers) would be best served by having a simpler and more transparent pricing approach.18

The first argument here, that costs are unrelated to use, is strange given the decision to base pricing on a gross tonne km use that implies that costs do vary with use. The second argument regarding the size of the gap is also perplexing given that the goal of access regulation is to prevent abuse of access terms with high pricing. The Victoria approach is simply therefore to lower the ceiling. The gap is not the relevant consideration rather the basis upon which the ceiling is determined. A large difference between stand-alone costs and variable costs would normally be an

18

DOI, op.cit., p.19.

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Section 3

Other Rail Access Pricing Regimes

argument to consider investment costs in the basis of a price ceiling rather than to neglect them as is done here. Nonetheless, it is true that neglecting an entire class of costs does make pricing simpler and potentially more transparent. However, in this case, it is unclear how that serves the interest of the access provider although to the extent that it fosters a low access price it is likely to be in the interests of the access seeker.

3.2

International

Rail networks in other countries do have substantially different geographic conditions than those in Australia. Moreover, the integration and density of rail lines are higher; making congestion issues more salient. Finally, in many jurisdictions, rail investment is still a government responsibility and so the rate of return requirements are different to those in Victoria. Nonetheless, looking at table 6.2 in the Appendix to this report one can see the common use of multi-part tariffs with fixed access charges to assist in the recovery of fixed and investment costs and also usage charges related to usage costs on a per km or gross tonne/km basis. This indicates the potential non-linearity between weight and distance that is neglected in the proposed Victorian pricing regime. Once again this suggests that accounting for investment costs is both feasible and implementable as part of access pricing without loss of transparency and potentially, where negotiations are possible, without the exclusion of access seekers specialising in low-demand forms of freight.

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Section 4

4

Towards a More Efficient Pricing Structure

Towards a More Efficient Pricing Structure

The experience in Australian and elsewhere demonstrates that the type of pricing structure proposed for Victoria is almost unique; especially in its disregard for investment costs. However, as demonstrated in Section 2, the pricing structure also poses problems for allocative efficiency, in that usage charges exceed marginal cost, and productive efficiency, because there are limited incentives for the network operator to engage in cost reductions. Indeed, there are potentially incentives for costs to rise. A preferred solution would be the following: •

A multi-part tariff with both fixed and usage charges.

•

The usage charges could reflect an appropriate unit of the service, likely to be contingent on the type of freight, as well as be a price cap rather than a cost-plus price.

•

The fixed charge could be designed so as to facilitate the efficient recovery of investment costs utilising demand-side information to reflect a downstream access seeker’s value on access as well as incentives to prevent by-pass or cream skimming.

This type of pricing structure is both implementable (as demonstrated by experience elsewhere) as well as preferable on all dimensions of economic efficiency.

4.1

Taking into Account Investment Costs

A principal requirement of any pricing structure would be to take into account investment costs. Some economists believe that this should be done through a simple linear pricing, or usage charge, that reflected all

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Section 4

Towards a More Efficient Pricing Structure

of the costs associated with a line.19 However, to do this would cause distortions to allocative efficiency in that a seeker’s decision to run an additional train across the line will be dependent upon average costs rather than marginal or incremental costs. To overcome this problem, economists in general recommend a multi-part tariff. The usage charges effectively reflect incremental costs while the fixed component is designed to contribute towards investment costs and generate appropriate investment incentives. Notice that it is critically important that fixed charges do not relate to usage in this case; as demonstrated by the lawnmower parable: Notice that the reasoning of the Joneses would not change if access seekers, such as Smith for the mower, were forced to contribute towards capital according to use. To see this, suppose that Smith also was forced to pay Jones for one seventh of the capital costs (given that they use the mower for only one day per week). A potential investor, such as Jones, would still be better off waiting for another household to purchase the asset. In this case, that provider would have to bear most of the capital costs associated with the necessary idleness that accompanies mowers and weeders. As providers of an asset are not compensated for idleness that arises in such lumpy investors, under such access regulation they are better off being a seeker rather than a provider. The idea of economic efficiency is not confined to the efficient use of assets that have been created, it can also be applied to the decision to invest in new assets. In particular, efficient investment requires that investment takes place at a time that will maximise the net benefits to society as a whole. For Smith and Jones’ street, access regulation based on simple cost recovery rules, while encouraging efficient utilisation of assets, discourages efficient investment. Even purchases that might have been individually optimal are delayed. Access regulation that does not respect the incentives to invest encourages a problem of

19

John Freebairn, for example, recommends a marginal cost plus mark-up to ensure recovery of all the network’s costs. His reasons are that this is simple than say a two-part tariff. However, this neglects demandside information as well as not providing incentives for cost reduction. It is basically a similar scheme to that advocated for other Australian states. See John Freebairn, “Access Prices for Rail Infrastructure,” Economic Record, 74 (226), September 1998, pp.279-285.

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Section 4

Towards a More Efficient Pricing Structure

free riding among potential providers. For these situations, the access regime that focuses exclusively on efficient usage can potentially discourage provision and hence, discourage any usage at all. 20

Nonetheless, by fully allocating costs based on the relative value a seeker places on the access service, it is possible to recover investment costs efficiently while creating socially desirable investment incentives.21 Such pricing principles could also be applied to new capital expenditure. Because the provider expects to share in the total costs of that expenditure, the provider has an incentive to choose that investment wisely. In this case, the fixed charges would not allow for a rate of return on investment and could be based on actual expenditures; the so-called historic cost approach to asset valuation.22 This would make the revision of access pricing in the face of new investment both simple and transparent to all concerned. Finally, the relative value way of apportioning investment costs also makes it easier to eliminate the costs of cream skimming. Access seekers serving more valuable customer classes will not receive special privileges and will be forced to contribute more to fixed costs. Thus, cost recovery will mirror Ramsey-style logic thereby removing potential distortions of each downstream competitor’s customer bases.

4.2

Incentives for Cost Reduction

While a multi-part tariff can ensure that allocative and dynamic efficiency are enhanced, if the usage charges are purely cost-based, this

20

Gans and Williams, op.cit., p.268.

21

For an economic analysis of the appropriate basis for valuing assets in the context of access regulation see Joshua Gans and Philip Williams, “Access Regulation and the Timing of Infrastructure Investment,” Economic Record, Vol. 79, No.229, June 1999, pp.127-138. 22

This approach has been suggested for electricity transmission network expansion. See Joshua Gans and Stephen King, “Options for Electricity Transmission Regulation in Australia,” Australian Economic Review, June 2000 (forthcoming).

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Section 4

Towards a More Efficient Pricing Structure

does not provide high incentives for the access provider to contain costs and maintain track quality. This is because they are only forced to bear a fraction of the costs concerned. A high-powered incentive scheme would have the usage charges take a form of a price-cap. In this environment, while the initial basis for the charge is cost-based, the regulator sets forth a pre-determined price reduction based on forecasts of efficiency improvements and the like and commits to this price path of a period of time. Consequently, the network will appropriate all of the cost reductions below that path over the period and bear any cost blowouts. This gives it large incentives to contain costs. Notice that these incentives are achieved by agreeing to cede to the network operator some rents; especially arising from cost reduction. Some people raise concerns that this means that the network will earn some monopoly profits. However, when providing incentives it is often the case that some rents must be left with the agent who is making the critical decisions. In this regard, the rents are simply and incentive bonus (or penalty) and not monopoly profits per se.23

4.3

Consistency and Transparency

The current pricing arrangement leaves many factors unaccounted for – in particular, the allocation of network and new investment costs. In addition, it is inconsistent in its application across different aspects of rail in Victoria. For this reason, it is important that any pricing scheme become more detailed in considering these issues. Leaving key questions of rate of return and cost allocation at the discretion of the regulator creates a poor climate for investment and economic efficiency. Thus, there is an immediate need for greater clarity in terms of the pricing guidelines currently given.

23

Laffont and Tirole, op.cit., 1999.

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Section 5

5

Conclusions

Conclusions

The proposed access-pricing regime for Victorian freight rail falls far short of standard criteria of economic efficiency. While it does promote downstream competition, it does so imperfectly and in the process virtually destroys the network operator’s incentives to reduce costs and efficiently invest in quality improvements and new capital expenditures. In this sense, it represents a form of regulation that neglects thirty years of regulatory experience and economic analysis. But more critically it sends very poor signals to potential infrastructure investors in Victoria. The total neglect of asset value and the inability of the provider to recover its past investment costs from seekers gives providers very poor incentives to invest in infrastructure assets that may be subject to access regulation. At best, it creates additional uncertainty about an investment’s rate of return while, at worst, makes investment in those assets of little private value. Economic theorists have often mused about the notion that sunk assets need not be recovered through regulatory pricing because the assets would remain even if the regulated firm failed while it would be easier to implement a low pricing outcome. Of course, this musing was well understood to be based on a myopic viewpoint and regulators everywhere have never taken such theoretical notions seriously. As a practical matter, regulatory decisions send signals to the market place about the future value of investment decisions and cannot be ignored. That they have been ignored in the proposed pricing arrangements raises much of concern about future regulatory decisions in Victoria. In general, access regulation as a very useful means of promoting downstream competition while preserving the efficiency benefits of natural monopoly infrastructure. Indeed, the usual concern over such regulation has long been that too great a proportion of investment costs are included in usage charges and that the better means of recovering these is through fixed charges. This way of regulating access to rail has been successfully implemented elsewhere and it would seem appropriate to impose a multi-part tariff form of access pricing for the Victorian case.

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Section 6

Tables: Approaches to Freight Rail Access Pricing

6

Tables: Approaches to Freight Rail Access Pricing

6.1

Australian Approaches State

NSW

Western Australia

South Australia

NT/SA AustralAsia Railway

Queensland Tasmania

June 2000

Pricing Methodology Floor/ceiling approach based on direct costs/stand alone line costs Floor/ceiling approach based on incremental costs/stand alone line costs Floor/ceiling approach based on break even and ‘fair’ return levels If effective competitive substitute, competitive imputation pricing rule. If no effective competitive substitute, floor/ceiling approach based on incremental costs/stand alone line costs Not yet chosen Not yet chosen

Asset Valuation Method Depreciated Optimised Replacement Value Gross Replacement Value Depreciated Optimised Replacement Value

Depreciated Optimised Replacement Value with adjustment for government subsidy

n.a. n.a.

29

Section 6

6.2

Tables: Approaches to Freight Rail Access Pricing

International Approaches Country

Pricing Methodology

Ownership and Control

Austria

Multi-part tariff with Government fixed charge, and variable components based on gross tonne/km and train-km

Denmark

Multi-part tariff with Government fixed charge, and variable components based on gross tonne/km and train speed

Finland

Multi-part tariff with Government variable components based on gross tonne/km and net tonne

France

Multi-part tariff with Government fixed charge, and variable components based on train km and a reservation charge

Germany

Charges differentiated Government by type of route, quality of the route, 5 freight categories with adjustments for weight, reliability and high volume

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Section 6

Tables: Approaches to Freight Rail Access Pricing

Sweden

Fixed charge per axle Government per year which varies (Subsidised) between types of rolling stock; variable charge based on marginal cost with a charge per gross tonne km differing between types of rolling stock and an operations charge per train km; a traffic control charge on the basis of train-kms. There is also provisions for differential pricing and also incentive payments with bonuses and fines

United Kingdom

Multi-part tariff with Franchised usage charge based on incremental costs and a fixed charge designed to recover fixed network costs with the use of a price cap process.

United (AmTrack)

June 2000

States Avoidable costs on per Government train-km basis with (Unsubsidised) incentive payments and penalties based on performance.

31

Attachment A: Recent Research Selected Recent Research Papers and Publications by Joshua Gans24

Competition Policy and Regulation: Joshua Gans and Stephen King, “Options for Electricity Transmission Regulation in Australia,” Australian Economic Review, June 2000 (forthcoming). Joshua Gans, “The Competitive Balance Argument for Mergers,” Australian Economic Review, Vol.33, No.1, March 2000, pp.83-93. Teresa Fels, Joshua Gans and Stephen King, “The Role of Undertakings in Regulatory Decision-Making,” Australian Economic Review, Vol.33, No.1, March 2000, pp.3-16. Joshua Gans and Richard Scheelings, “Economic Issues Associated with Access to Electronic Payments Systems,” Australian Business Law Review, Vol.27, No.5, December 1999, pp.373-390. Joshua Gans and Philip Williams, “Efficient Investment Pricing Rules and Access Regulation,” Australian Business Law Review, Vol.27, No.4, August, 1999, pp.267279. Joshua Gans and Philip Williams, Access Regulation and the Timing of Infrastructure Investment,” Economic Record, Vol. 79, No.229, June 1999, pp.127-138. Joshua Gans, “Regulating Private Infrastructure Investment: Optimal Pricing for Access to Essential Facilities,” Working Paper, No.98-13, 1998, Melbourne Business School.

Telecommunications: Joshua Gans, Stephen King and Graeme Woodbridge, “Numbers to the People: Ownership, Regulation and Local Number Portability,” Working Paper, No. 200008, Melbourne Business School.

24

M any of these papers can be accessed on the web through www.mbs.unimelb.edu.au/jgans/research.htm.

Attachment A

Recent Research

Joshua Gans and Stephen King, “Using ‘Bill and Keep’ Interconnect Arrangements to Soften Network Competition,” Economic Letters, 2000 (forthcoming). Joshua Gans and Stephen King, “Mobile Network Competition, Customer Ignorance and Fixed-to-Mobile Call Prices,” Information Economics and Policy, 2000, (forthcoming). Joshua Gans, “Network Competition and Consumer Churn,” Information Economics and Policy, 2000, (forthcoming). Joshua Gans and Stephen King, “Termination Charges for Mobile Phone Networks: Competitive Analysis and Regulatory Options,” Working Paper, No.99-19, Melbourne Business School, December, 1999. Joshua Gans and Stephen King, “Regulation of Termination Charges for Non-Dominant Networks,” Working Paper, No.99-20, Melbourne Business School, December, 1999.

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Attachment B

Consultant Profile

"Incumbency and R&D Incentives: Licensing the Gale of Creative Destruction," (with Scott Stern) Journal of Economics and Management Strategy, 2000 (forthcoming).

Attachment B: Consultant Profile

"Options for Electricity Transmission Regulation in Australia," (with Stephen King) Australian Economic Review, 33, June 2000 (forthcoming).

JOSHUA GANS Joshua Gans graduated in 1994 with a Ph.D. in Economics from Stanford University. His thesis concentrated on the determinants of economic growth and the role of technological progress. He returned to Australia as a lecturer in the School of Economics, University of New South Wales. In 1996, he moved to Melbourne to take up a position as an Associate Professor at the Melbourne Business School, University of Melbourne. At present, Joshua is Economics Editor of the Australian Journal of Management and on the editorial board of Information Economics and Policy.

“The Role of Undertakings in Regulatory Decision-Making,” (with Teresa Fels and Stephen King), Australian Economic Review, 33, March 2000, pp.3-16. "The Competitive Balance Argument for Mergers," Australian Economic Review, Vol.33, No.1, March 2000, pp.83-93. “First Author Conditions,” (with Maxim Engers, Simon Grant and Stephen King), Journal of Political Economy, 107, 1999, pp.859-883.

Joshua teaches MBA students introductory microeconomics and also several specialised subjects on innovation, game theory and incentives and contracts. He has adapted a leading US textbook for the Australasian context; Principles of Economics (co-authored with Stephen King, Greg Mankiw and Robin Stonecash; published by Harcourt-Australia).

"Efficient Investment Pricing Rules and Access Regulation," (with Philip Williams) Australian Business Law Review, 27, August 1999, pp.267-279. "Why Referees Don't Get Paid (Enough)" (with Maxim Engers), American Economic Review, 88, December 1998, pp.1341-1349.

Joshua has also had extensive consulting experience working on competition issues for several law firms, private utilities and government agencies including the Australian Competition and Consumer Commission. His work spans a wide variety of industries including telecommunications, electricity, gas, pharmaceuticals, banking and financial services.

"Growth in Australian Cities" (with Rebecca Bradley), Economic Record, 74, September 1998, pp.266-278. "Industrialisation with a Menu of Technologies: Appropriate Technologies and the Big Push", Structural Change and Economic Dynamics, 9, 1998, pp.63-78.

On the research-side, Joshua specialises in industrial organisation and applied game theory. His particular interest is on the link between competition and innovation. He has also researched on the publication process in academia and his papers are part of a forthcoming book Publishing Economics (to be published by Edward Elgar in 2000). Some examples of his publications include:

"Contracts and Electricity Pool Prices" (with Danny Price and Kim Woods), Australian Journal of Management, 23, June 1998, pp.83-96. "Driving the Hard Bargain for Australian R&D,” Prometheus, 16, March 1998, pp.47-55.

"Network Competition and Consumer Churn," Information Economics and Policy, 2000, (forthcoming).

34

Attachment B

Consultant Profile

1