Fred Hilmer

The proposal by NBN Co that it should be freed up to allow it to compete with rival private operators such as TPG Telecom highlights the dilemma facing government when it seeks to achieve a social goal by creating a monopoly.

The NBN’s competition policy problems began from its conception when it was established as a legislated monopoly. The justification was that a monopoly, given its substantial power to set prices, would be able to offer an equivalent service at an equivalent price to all Australians, whether in the remotest outback or the high-density parts of the cities.

This goal, to be met via a monopoly (rather than a competitive model with transparent subsidies) was argued to be the best approach to establishing universal high-speed broadband access.

The NBN, however, is not a natural monopoly. The basis of the NBN monopoly is regulation, not economics. Natural monopolies – such as the electric power grid, the rail track or gas and water distribution networks – cannot be economically replicated by a competitor. Natural monopolies have considerable power to set prices without needing legislative protection and, hence, are subject to structural separation and price regulation.

Monopolies created by regulation rely on the regulatory barrier to be able to set prices and price structures. Without regulatory protection, much of what monopolies such as the NBN would like to do can be picked off by competitors, as TPG has demonstrated.

Hence, the only way the NBN monopoly can be protected is by cast iron, loophole-free regulation. However, monopolies created by regulation are inherently fragile. As George Stigler wrote, “Competition is a tough weed, not a delicate flower”. And tough weeds find even small cracks in the pavement to break through.

In the case of the NBN, there are two major “cracks in the pavement” that are becoming apparent even before the NBN is built. The first is cross-subsidy. Urban users have to pay more than the costs of serving them, while remote users pay less than cost. As a result there is an enormous incentive for potential competitors to break the monopoly and serve urban users at lower prices that nevertheless produce good profits. TPG may have found a loophole that allows this.

But I can confidently say that even if this loophole is closed, others will emerge. The reason is because of an even larger crack in the monopoly pavement – new technologies that erode monopoly power.

We have seen how legislated restrictions on competition can be blown away by technology. One need look no further than the media industry where cable and the internet have eroded the value of legislated TV licences. Importantly, these new technologies have created jobs and supported economic growth.

These two forces complement each other, as the financial incentive in serving the most attractive customers triggers technological innovation.

And herein lies the real dilemma, so often ignored when competition policy is debated. It is generally clear what competition, if allowed to work, will do to inefficient competitors or the products and services that are overpriced.

These consequences are highlighted as doomsday scenarios — the end of important and much loved activity and employment, such as an aircraft maintenance base or a call centre. Moreover, the pain is felt acutely by few, who can be quite vocal, while the benefits are diffuse.

But what is left out, and is generally unforeseeable, is the range of new jobs and new opportunities a competitive environment creates. Recall what happened when airlines were deregulated. Jobs were lost in the airlines, but far more jobs were created as coastal communities developed tourism and the second home market on a scale not imagined when the deregulation was proposed.

What then should the government do — keep cementing over cracks in the pavement, or accept that the monopoly is neither sustainable nor in the public interest? In the latter case, look after the remote users by direct subsidy rather than relying on an unstable monopoly? Maybe it is too late for such a fundamentally different approach.

But maybe the adage, “the first loss is the best loss” will again be proved right.

Professor Fred Hilmer is the vice-chancellor of the University of NSW. This post has appeared in The Australian Financial Review.