'Building Networks for a Brighter Future'
Speech Vice-Minister for Economic Affairs, Frank Heemskerk, at the opening of the conference 'Building Networks for a Brighter Future', on 10 November 2008 in Rotterdam
'Infrastructures and the role of government'
Introduction
Ladies and gentlemen,
These are unnerving times for government officials and policy makers. The world wide credit crisis seems to force us to revaluate the role of government in the economy. Some speak of the end of capitalism. They see the need for massive state interventions as proof that capitalism has failed. They want to reset the clock of deregulation and liberalisation. They ask the state to step in forcefully where the market so obviously failed.
Others argue, on the contrary, that crises are part of the deal, that they are an unavoidable by-product of growth and innovation. They point out that the financial world has a mere 1.000 years of history with many similar episodes. These experts stress that the government can only make things worse.
I believe the truth lays somewhere in the middle. Obviously, regulators deserve part of the blame for the present crisis. But the market is the first to blame. As a social democrat and as a member of government responsible for international trade and investments, telecom and consumer interests, I believe a strong economy requires a strong state. I believe there can be no true economic freedom without clear rules and strict control. And I believe it is not too much state involvement that created the present crisis, but too little.
So it is from this perspective that I will speak to you today. When we focus on infrastructures, what can be left to the market? How can we secure adequate investments? How to stimulate innovation? And finally, what institutions do we need to achieve those aims and what should be the role of government and regulators?
Let me answer first a simple question. What do we mean by infrastructures, and what are they about?
Infrastructures are all kind of systems essential to society for the transport of data, energy, goods or people. So infrastructures are not telephones, but telephone frequencies. Not trains, but railroads. Not electricity, but power grids. Not web pages, but the world-wide-web.
And what are infrastructures about? The motto of a major phone company says it all: "Connecting people".
Infrastructures are meant to go unnoticed. They should be a self evident part of everyday life. They should merely serve. And when they change, when old systems are being replaced by new ones, they should slip into people's routines almost unnoticed.
So the infrastructures should not serve in the first place the companies that sell services related to infrastructures. They should neither serve government nor regulators. They should serve the end users - consumers, businesses, and society as a whole. There are public interests to be secured here.
That is why I think this congress should look at infrastructures through the eyes of the end users. We must make sure that our infrastructures develop in a way that serve the interests of the users. We must make sure that the investments that are being triggered, are in their best interest.
Even to those of you who focus their research on topics like governance, institutional arrangements or business cases for infrastructures, I want to say: see what happens if you put the users first.
So we should focus on the user of the infrastructure. But the user should not focus on us! Because the infrastructure is noticed only when it fails.
Three reports, three I's
I appreciate the initiative of the Foundation Next Generation Infrastructures to discuss in this learned environment three recent Dutch policy reports on infrastructure.
The first report focuses on regulation and tariffs. It was by the Scientific Council for Government Policy, the WRR in Dutch, from which you will hear later on during this conference. The second report, written by Commission "Elverding", is about innovative planning procedures.
And the third, by the Commission 'Ruding', advised on private financing.
Forget for a while about 'triple A'credit ratings; my speech will focus on a 'triple I': investments, innovation and institutions.
The ministry of Economic Affairs is responsible for two important infrastructures - energy and telecommunications, which includes the world-wide-web. There is ample material to illustrate the points I want to make. They are about:
- where and how government should play its role;
- where government should merely remove barriers for a well functioning competitive market, and where, on the contrary, it should do more;
- and how liberalisation and network innovation play out.
You will notice as I speak that there are still plenty of open questions that cry out for an answer from you, the researchers and theoreticians.
One: ' I' for Investments
Why should government be involved in infrastructures at all? There are different reasons.
Infrastructures tend to form a natural monopoly. Railroads, for instance, or the natural gas grid. Others form a duopoly or at least an oligopoly, such as the internet infrastructures.
Other infrastructures use scarce public resources, such as a telecom frequency or - again - a railroad. In those cases, the government is involved to protect the physical environment and ensure a fair distribution of the limited resources.
And there are even infrastructures that combine both elements. High tension power lines are very difficult to plan in the scarce physical space in this country. At the same time, they form a natural monopoly.
These elementary differences in infrastructures explain why different infrastructures ask for different policies.
In order to protect the consumer against a monopolist, strict regulation of tariffs is essential. Nobody would advise that the regulatory bodies should let go of that task.
However, too tight regulations can smother any initiative. Network operators could then loose any interest in investing in the infrastructure. We have seen the results in California where the lights went out in 2000. That was due to an improper regulatory regime.
So in regulation, we need to find the right balance between efficiency and possibilities to invest. That is why the Dutch government wants to ensure that the infrastructure system operators have the means for long term investments.
The electricity and gas infrastructure form typical natural monopolies that operate under public ownership and strict tariff regulation. When facing investment decisions, network operators only act when they are convinced that the investment will be earned back.
That is why we chose a model in which an investment decision is considered to be a political decision. In the political arena, Parliament or local Councils weigh the pro's and cons of an investment. They decide. Next, the Regulator can focus on his job: securing an efficient way to finance the investment, in order to keep the use of public money low and the rise of tariffs to a minimum.
The telecom sector does not form a natural monopoly. And the government does not own the infrastructure. So there, the role of the government is different.
In the Netherlands, we will soon have three networks for broadband internet: one originating from the telephone network, the second one stemming from the RTV-cable network and a third one deriving from the emerging wireless network (based on UMTS). Both cable and telecoms are increasingly providing all different types of services: broadband internet, voice telephony and television broadcast. The wireless operators will soon join with competitive products.
Competition between these three infrastructures is fierce. Nonetheless, the government is involved to protect the end users. OPTA, our telecom regulator, keeps a close look on them and takes measures whenever the interest of the end users is at stake.
So we are in the fortunate position of having competing telecom infrastructures. Nonetheless, we favour "third party access" to the fixed telecom-infrastructures, just as is the policy for energy networks. Granting access of third parties to the infrastructure, increases the number of competing companies. We have seen this development in the fixed telephone network. The fixed RTV-cable network is to follow, as the cable operators will soon need to open their networks to new, third parties as well.
Increased competition between the different telecom infrastructures, gives operators a strong incentive to improving their networks.
So we see two different markets depending on its specific infrastructures and we see two different forms of government involvement: regulation of investments in cases of a natural monopoly, and competition driven investments in cases where more than one infrastructure is available.
Long term investments are needed to keep an infrastructure in shape. But there is another kind of investment as well: investments with the I from innovation.
Two: 'I' for Innovation
Infrastructures change over time as technology offers more efficient solutions for old problems.
But these developments are slow, as network operators tend to use only proven technology. Those that switch early to new technologies risk the lock-in effect: if the new technology turns out to be immature, replacement is no option because the initial investments were high and haven't been written off yet. So the first to switch to new technologies can loose their advantage quickly and for a long time.
The need for system rejuvenation can come from the market, but may be also an requisite for achieving important policy goals.
Politicians and businesses are the ones that call for "smart grids" in the electricity sector.
Recently, my minister published an ambitious program to tackle the energy challenges we are facing: an exploding demand, a supply crunch and the climate issue. To tackle these problems, we need a transition to a more sustainable energy system: cleaner energy from more different sources and supported by smarter infrastructures. We believe there is a future for solar panels and micro-combined-heat-and-power, which is your own power plant in the attic! But their rise requires significant changes in the way electricity is distributed.
The present network distributes electricity from power plant to end user. It must be made ready over a short period of time to accommodate a growing number of small electricity producers. System operators will address this challenge.
But, who will pay for this transition? We are back to the "I" for Investments: higher tariffs must allow for experiments and new developments. How can we provide incentives for innovations in this strictly regulated sector? Can we expect innovations from every network operator? And can we allow for network operators to take risks, that inevitably come with new, innovative solutions? Questions where answers are not readily available.
My conclusion is that the 'I'for innovation can only flourish, when the 'I' for Investment is secured. But that is not enough. The institutional environment must also be adequate.
So here is the tird 'I' for Institutions!
Three: 'I' for Institutions
Infrastructure can be a fully private business, as for instance the telecom sector. Another extreme are roads, that are for 100% a governmental affair in this country.
In all cases, the government concern is primarily with the end users of the infrastructure.
Most clearly, the government created new institutional arrangements in the energy sector. By law, the infrastructure for electricity and natural gas must be completely split from the production and trade in these commodities. With this ownership unbundling the government makes a clear statement: where the infrastructure is a natural monopoly, public interests can only be secured when private influence is excluded. We believe the end user can truly benefit from the free market only if the infrastructure is available for all competing suppliers, and only if the infrastructure fulfils high quality standards.
And competition does take place. The energy prices for end users are proof of that.
In general, the government should keep its eye on public interest. This means it must limit private involvement whenever private interests override the interests of society as a whole, or the interests of the end users.
I will give you two examples.
The Dutch government has played an important role in creating SURFnet. The government provided the funds for SURFnet to invest in very costly infrastructural innovations. Although the benefits and potentials of SURFnet were clear to many parties, none of these parties could take the risk of such large an investment. A typical institutional barrier. Government lifted this barrier by providing for the initial funding. Those costs are now being repaid by the users of the SURFnet network - research institutions, R&D departments of big companies, universities and hospitals.
The government involvement has resulted in the creation of the Amsterdam Internet Exchange. Today, it is the biggest internet hub in the world. It definitely attracts foreign investors and companies to the Netherlands. And SURFnet is now the fastest and most innovative research network in the world.
As a by-product, we also have the highest density of internet broadband connections in the world after Sweden, with 35 connections per 100 inhabitants. The market took care of that itself, but these immeasurable benefits are facilitated by the government funding of SURFnet.
The other example is at the opposite. Here, private parties saw a profit and tended to engage in cherry picking at cost of the public interests. Recently, European jurisdiction has drawn everybody's attention to this problem. I talk about private energy networks: a number of end users, sharing one connection to the public grid.
Basically, there is nothing wrong with a private network for gas or electricity. But this changes when these networks are economically justified by avoiding the costs of the public services, such as balancing the electricity network. Also the quality of a private network may be lower than the public network, thus risking a deterioration of the quality of the network as a whole. Finally, private networks tend to infringe on the free market for energy products. In the end, all of these effects harm the end user.
That is why Dutch government will review the criteria for creating a private network in order to keep the playing field level and to protect the end users. I expect the new criteria will be announced in about half a year.
Conclusion: the role of government
To conclude, let me come back to my initial question: what is the role of government and regulators? Based on the lessons of the telecom and energy markets, I distinguish five tasks.
First, the government must secure a very high quality level of infrastructures. Failure must be avoided as much as possible.
The Dutch power supply has a good track record of 99,998 % availability. But this still means an average failure of 30 minutes a year.
So secondly, in order to guarantee those high standards, the government must provide for strict and intelligent regulation. Not only on the national market, but also in cross border co-operation as the market becomes increasingly international.
Thirdly, the government must safeguard sufficient investments in the infrastructure. Even when the economy takes a bad turn.
Fourth, the government must stimulate network operators to innovate and at the same time enable end users to use the new innovative infrastructures safely and securely. The risks involved in innovation may not be a burden to the end users.
And last but certainly not least, the government must protect the users from being squeezed by monopolists or other dominant players, especially where these monopolists are created by government.
In Holland, we focus on the three "I's". We work at improving the regulatory framework and the incentives for investment. We work at improving the opportunities for innovation. And we work at better institutional arrangements and lifting barriers
In short: strengthening the institutions that protect the end users while fostering investments and innovation.
I believe government, universities and private companies must work together on improving infrastructures and infrastructure policies. Infrastructures are too important to be left in the hands of one group.
So, let me act on this statement. Please come forward with your questions or comments!
Thank you for your attention.