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Japanese Economy Update

Deregulation of Public Utilities in Japan

 

2019/05/07

Government regulation of public utilities that were in place

Industries that provide basic goods and services that form the basis of peoples’ lives and industrial activities are called “public utilities”. They include, among others, industries such as electricity, city gas, and telecommunications that require huge fixed assets so that their business would show economies of scale and lead to natural monopolies. For that reason, governments have introduced a set of regulations to insure reasonable and stable provision of their products.

Japan is no exception. After the World War II, it has established a set of regulations that includes the following.

First is the regulation on new entry. The government allowed the agents supplying the products monopolies: regional monopolies by private companies in the case of electricity and city-gas, and a national monopoly by a public company in the case of telecommunications. As a result, they were shielded from pressures coming from competitors to be more efficient.

Supply of public utilities involve a set of different sub-sectors: for example, in the case of electricity, it consisted of power generation, power distribution, and power retail. However, the companies were allowed to vertically integrate these sectors and were allowed national or regional monopoly in the whole industry.

Second is the regulation on prices. As a result of the monopoly status given, the prices set by supplying public utilities were subject to regulations by the government. Therefore, the government introduced a system which required the companies to submit proposals for any price changes and get them approved by the government.

Since the industries shows economies of scale, marginal cost is lower than the average cost so that setting prices at marginal cost will not allow companies to be viable. As a result, the government required the prices to be set on the basis of their average costs (full-cost principle).

Third is the requirement of universal service provision. Since monopoly status is given to the provision of fundamentally important products, it was important for the government to assure fair and equal provision of public utility to all citizens. The suppliers were obliged to supply products to those anyone requesting to have access.

Providing universal services means that they had to bear the cost. The regulation assumed that cross subsidization would take place between profitable and unprofitable business areas in their respective industries.

Deregulation of public utilities taking place since mid-1980s

Such a regulatory regime existed until mid-1980s. However, the problems with this regime gradually became apparent in late-1980s. Particularly important was the impact of the findings by the surveys on the price differences between domestic and foreign markets. They found that the prices of public utilities in Japan were considerably higher than those in other countries. From hindsight, it was somewhat exaggerated by the overvaluation of the yen at that time. However, it led to an review of the efficiency of the public utility industries and brought some changes to their regulation.

First, government introduced a price setting system that emphasized incentives to be provided to the companies providing public utilities. They include “yardstick rules” that allowed comparison of efficiency in price assessment; “price cap system” that allowed prices to be flexible below the cap; and “fuel price adjustment system” that allowed automatic prices revisions when fuel prices changed.

Second, entry restriction was relaxed to allow more competitive pressure on the incumbent companies. In the telecommunication industry, privatization of the monopoly public company took place in 1985, and new entrants were admitted to the long-distance and local calls. In the electricity industry, entry to power generation and a partial liberalization of power retail were introduced in 1995.

Unbundling and identification of essential facilities

Furthermore, unbundling of the businesses that were considered to be natural monopolies were made. As mentioned earlier, the vertically integrated systems of the network industries were given monopoly status in whole industry concerned. However, essential facilities that have natural monopoly nature were identified and distinguished from the rest of the business. Essential facilities are the distribution system in the case of electricity and the local phone network (the last-one-mile network) in the case of telecommunications. These facilities were obliged to provide access to third parties, and the standard access terms and conditions, including access charges, had to be approved by the government. On the other hand, those business that were identified as non-natural monopoly areas were liberalized.

In addition, in the case of telecommunications, while it did not have a natural monopoly nature, mobile communication network was also provided access to third parties because of the strong bargaining power held by the incumbents that shared among them the frequencies that were limited in supply.

Regulations in electricity were amended since 2000 so that retail of electricity were gradually liberalized from factories to households which was completed in April 2016. Retail of city gas was also liberalized in April 2017.

Regulation of telecommunications were also revised in 1997, in the case of fixed communication network, and in 2001, in the case of mobile communications network. Allowing access to the latter has led to many mobile virtual network operators (MVNOs) staring business in mobile phones.

Separation of essential facilities are expected to take place

Essential facilities are still held by the former monopoly and regional monopoly companies. In order to assure equal and fair treatment of competitors that want access to the facilities, the essential facilities should be separated from those large dominating companies. In the case of electricity, distribution system is expected to be legally separated from other sectors from 2020. In the case of city gas, the pipeline system, which is the essential facility in the industry, is also expected to be legally separated from 2022.

However, legal separation is different from ownership separation in that it allows the company with essential facilities to be under the same shareholding company along with other companies that are in competition with competitors. We need to see whether the arrangement is enough to convince the competitors that their access to the essential facilities are fairly and equally treated.


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