New Zealand's Competitive Environment

New Zealand's Competitive Environment – Business as Usual or Room for Improvement? Speech to Competition Law & Regulation Review Conference, Duxton Hotel, Wellington

Thank you for inviting me to open the proceedings here today.

I noted the title of the conference this year: “Examining New Zealand’s Competitive Environment – Business as Usual or Room for Improvement?”

The current competition law and regulatory reform agenda which falls under my Commerce portfolio has been about taking stock of New Zealand’s regulatory environment and asking the question – business as usual or room for improvement? That means being willing to put the resources into change where it is necessary, but also about leaving well enough alone where appropriate.

Parts 4 & 4A of the Commerce Act fell very squarely into the former category and although I am going to address other aspects of the reform agenda, given your agenda I felt it was important that I update you on the decisions government has made in that regard.

There are two preliminary points that I want to make. First I want to acknowledge the contribution and support received from those of you who made submissions, either directly or on behalf of clients, to feed into the policy development process.

Personally, I consider that the review process and the review outcomes have been a great success, in terms of the Labour-led government and business working together to deliver solutions that work for business, which will ultimately benefit the New Zealand economy as a whole.

The second point I want to make is this. The solutions to some of the challenges we face in developing appropriate regulatory frameworks for a country our size, so distant from its international markets and with such a small domestic market, involves a balanced approach. I have made the point several times that I don’t appreciate the characterisation as heavy-handed vs light-handed. Different circumstances call for different approaches and the purists amongst us, regardless of the end of the spectrum, have to settle for less than theoretical perfection in the face of practical reality.

I think we have got the balance right and I am sure that there will be those in the room who will agree and those who will disagree, so I look forward to a robust discussion after this address.

I am on track to having the Commerce (Regulated goods and services) Bill introduced into the House mid-March. Although the select committee process usually takes up to 6 months, I am hoping that we have the detail sufficiently agreed before introduction that the process may take less than that, which means the Bill could be passed before the election. Although I haven’t got the assurances of other parties at this stage, there seems to have been a favourable response to the announcements I made last year and most of the commerce bills have been dealt with in a reasonably non-partisan way.

In order to help achieve this timeframe, officials ran a further round of consultation on the design detail of the new regulatory regimes with key interested parties in parallel to the drafting of the Bill. This proved to be very constructive. I have been briefed on some changes that were proposed as part of this process and my colleague (the Minister of Energy) and I are in the process of signing off on those.

Overwhelmingly, the main message coming from submitters is that the need for certainty is of the utmost importance. Businesses have said that they need certainty around the scope of regulation and the timing of key aspects of the regulatory change programme.

Regulated businesses want to know, as far as practical, what the rules will be, so they can better function as individual businesses and, as an industry, the better they will be placed to meet the government's objectives for increased innovation and investment in infrastructure.

Another common theme from submitters was the very high interest around the transitional arrangements for regulated firms. I am hoping that we may be able to provide a greater degree of certainty around the timetabling of decisions – for example, by when the Commerce Commission needs to set input methodologies

The Part 5 review is on a slower track. There are some important issues in this stream of the review, such as the timeframes around merger clearance applications. Officials will be presenting me with policy proposals in June this year and any new legislation will be introduced in 2009.

So that is where the government is at in terms of process.

As I indicated earlier, I would like to use the rest of my time talking about how competition policy has evolved in New Zealand, and the rationale for, and new approaches addressed by, the new Part 4 of the Commerce Act.

Competition Policy and New Zealand
We know that New Zealand is unique. We are a small, developed but isolated nation, at a great distance from many of our markets, with a small population spread over a geographically challenging landscape.

The application of competition policy in New Zealand creates many challenges for us.

Most obvious in this is that our markets are very small compared to other developed nations and barriers to market entry can be high. We simply do not have sufficient firms with scale and scope to effectively compete in international markets. Our one global company of real significance is Fonterra, and that required the government's support to lift it over the threshold set by the Commerce Act.

Competition and monopoly
What we must remember is that competition is a means to an end – it is not an end in itself. There are clearly situations where rather than providing for efficient outcomes the pursuit of competition would instead be inefficient.

In addition, there may be other objectives other than the efficient allocation of resources that matter to a society, such as social or environmental goals.

This being the case, the main issue to consider is the extent to which competitive forces in an economy encourage all businesses to behave in ways that promote the interests of society as a whole.

The Review
New Zealand’s regulatory environment for natural monopolies has evolved differently to most other jurisdictions. Major infrastructure monopolies had always sat in the hands of local and central government ownership until the 1980s. Tragically for New Zealand the separation of infrastructure from the business did not occur at the time privatisation was occurring, nor were appropriate regulatory frameworks put in place to protect consumers from what followed.

Under the threat of regulation the relevant firms spent too much time and effort trying to anticipate how the government of the day and the Commerce Commission would react to certain conduct.

This situation had become a game which relegated sound economic outcomes, business certainty and the protection of consumers to second place. The “threat of regulation” system did not result in good outcomes for consumers or the economy as a whole.

The review of Parts 4 and 4A has been largely about moving New Zealand back into the international mainstream, creating a new regulatory system that will promote efficiency, innovation and investment, and protect consumers.

The absence of a regulatory specific purpose statement under the existing Part 4 of the Commerce Act has led to dispute and uncertainty because the overall purpose of the Commerce Act applies by default; that is, “to promote competition in markets for the long term benefit of consumers”.

This purpose statement does not fit the circumstances for markets, such as New Zealand's, where there is little or no scope for competition.

For this reason, at the very beginning of the process, the review of the Commerce Act canvassed what the purpose of economic regulation in New Zealand is, or should be.

Further, business uncertainty was generated by the Act’s requirement that sequential inquiries be carried out on firstly whether to regulate and then if the answer is "yes", secondly on how to regulate. The application of this process has proven to be extraordinarily time consuming and has involved a high degree of cost and duplication.

To date, the Commerce Commission has carried out two Part 4 regulatory control inquiries in relation to gas pipeline services and airfield activities. In carrying out these inquiries, the Commission was not able to consider alternative forms of regulation as a means to address the competition problems. This is another identified problem of the Commerce Act in its current form.

If the Commerce Commission considers that a lighter-handed regime relative to price control is beneficial, the government would be required to separately legislate to introduce the new regime.

And in addition, it appears that other countries’ experience with forward looking, incentive based forms of regulation represent a significant advance on regulatory methods used prior to the 1980s and 1990s.

Electricity lines businesses in particular were telling the government that the Part 4A thresholds regime has had the unintended side effect of generating an environment of business uncertainty, and crucially, perversely effecting incentives to invest in infrastructure.

In theory, the concept of the Part 4A thresholds regime is simple. In practice it has not worked as well as was hoped.

27 of the 28 electricity lines businesses have breached the thresholds at some point and there have been over 100 individual instances of breaches since the regime was introduced in 2003. Some breaches have been minor or technical in nature, or related to the need to engage in major new investment.

However, the potential consequences of any breach under the Part 4A may be significant and disproportionate to the nature of that breach. This uncertainty generated by a lack of predictability and transparency, undermines business incentives to maximise efficiency gains within the price cap threshold and discourages future investment.

The government agrees that the focus of all economic regulation should be a cooperative, forward-looking and incentive-based, where the regulator and businesses work collaboratively to seek to mimic the outcomes of competitive markets.

Consequentially, it is proposed that Part 4A will be repealed and all regulatory control provisions will be provided for under a single regulatory framework, which will provide for alternative forms of regulation in addition to conventional price control.

In addition, there have been a number of claims in recent years that the threat of regulation is not real because there has been a belief that there is no political will to intervene. This is linked to the lack of certainty about the circumstances that would trigger stronger regulation, particularly price control.

This tends to undermine the credibility of the threat of price control as a regulatory response to concerns about the potential for monopoly pricing.

Businesses are unsure about the bounds of acceptable behaviour. There has been a real lack of specificity in the rules. This has had adverse effects on their decision making and on the economic performance of firms in the business of providing essential infrastructure.

The solution then has been to clarify and define to the full extent possible, what behaviour will trigger extra regulation.

Thus, the new Part 4 of the Commerce Act has been designed to provide for economic regulation in New Zealand that will strive to achieve the right balance between providing businesses with incentives to achieve efficiencies, to seek innovation and to invest, within clearly defined rules, while protecting consumers from poor quality, restricted output, or unnecessarily high prices.

So that is a quick outline of the rationale behind the amended Commerce Act.

Conclusion
And that concludes my stocktake today of our regulatory environment in the context of competition law. In particular, I want to highlight the government's desire to take a fresh look at the way in which we regulate businesses that have natural monopoly characteristics.

I am confident that the changes will provide greater certainty to businesses, investors and consumers. They will also ensure that regulatory intervention is proportionate to the competition concerns and that business compliance costs are kept to a minimum. This will help businesses plan and make investments.

I have said it before. New Zealand is unique in that competition law and regulatory control governed by same Act and enforced by the same entity. The prevailing view is that this is entirely appropriate for our small size and limited resource.

But it does mean that we all face unique challenges in administering the Act effectively.

The Labour-led government’s reviews are not about moving along the regulatory spectrum between the polarised construct of “light versus heavy-handed” regulation. The reviews are about establishing a quality regulatory regime that, first and foremost, is the best fit with our economy, given our country’s relative isolation, market size, geography, population and pool of resources.

The Parts 4 and 4A review was considered timely and was thus well received by the business community. Submitters put a great deal of effort into their participation in this important policy development process.

Our competition law and regulatory framework needs to balance the trade-off between flexibility and certainty. We all want New Zealand to continue to grow on the world economic stage, so that domestically we prosper. This will involve an assessment from time to time of that trade-off, to make sure we have the balance right, to achieve our goals.

Thank you.