WHAT ECONOMISTS NEVER TOLD US: THE ELUSIVE SOLUTION TO HIGH PUBLIC SERVICE RATES

WHAT ECONOMISTS NEVER TOLD US:

THE ELUSIVE SOLUTION TO    

HIGH PUBLIC SERVICE RATES

 

 

All of my writings, all of my recommendations, all government reforms that have to be undertaken towards reduction of our unduly high public service rates, have to culminate in what I wrap up in this paper. If there is a “magic formula” towards reasonable power, water, telecom, toll-road, and other service rates in captive markets attended to by public interest, this is it.  

 

 

PART I

THE CASE FOR REGULATION

OF CAPTIVE MARKETS CLOTHED

WITH PUBLIC INTEREST

 

OBSERVE THAT ALL OF OUR HIGH POWER,

WATER, TELECOM, AND TOLL-ROAD RATES

ARE ROOTED FROM A COMMON DENOMINATOR:  

LACK OF ENFORCED SAFETY NET AGAINST

OVERPRICING:  RATE-OF-RETURN LIMIT 

 

THE SOLUTION THEN TO OUR UNDULY HIGH

PUBLIC SERVICE RATES IS ENFORCEMENT

OF REASONABLE RATE-OF-RETURN CEILING

 

TO BEGIN WITH,

THE BASIC PREMISE OF DEMOCRATIC GOVERNANCE:

THE GREATEST GOOD FOR THE GREATEST NUMBER

 

Under Article II of the Constitution: “The Philippines is a democratic and republican state. Sovereignty resides in the people and all government authority emanates from them…. The prime duty of government is to serve and protect the people.”

 

In effect, our Constitution and laws have adopted the majority rule as normal basis of decision making, with simple majority of one or two-thirds majority as winning vote on crucial issues. In essence, majority rule translates to the greatest good for the greatest number under democratic governance.

 

 

Free-market Economists have Ignored

the Greatest Good for the Greatest Number

in the Privatization of—or  Awarding of Franchises

in—Captive Markets Clothed with Public Interest,

Thereby Resulting in Unduly High Public Service Rates

 

Our very high public service rates, which stick out like a sore thumb in Asia, is an economic problem that has victimized not only big and small businesses but also generally poor consumers and commuters nationwide. We have abnormally high power, water, telecom, and toll-road rates in the region. We also have very high medicine and agro-chemical prices. For example, our second highest power rates in Asia (next only to those in Japan) have for so long served as heavy burden to business and stumbling block to our rapid industrialization and faster economic growth.

 

 

 

THE ROOT AND COMMON DENOMINATOR

OF OUR VERY HIGH PUBLIC SERVICE RATES:

LACK OF ENFORCED RATE-OF-RETURN CEILING

ON ALL—REPEAT ALL—PUBLIC SERVICE PROVIDERS!

HOW THIS CAME ABOUT IS UNFLATTERING TO

THE PHILIPPINE ECONOMICS “PROFESSION” 

 

There is a common denominator or cause of our unwarrantedly high public service rates in the power, water, telecom, toll-road, and probably other public service industries that cater to mass consumers and commuters—lack of properly enforced rate-of-return limit on government authorized public service providers. Obviously, if there is an effectively implemented profit-rate ceiling, EVEN IF THERE IS NO COMPETITION, public service rates cannot go beyond reasonable levels—this is basic and plain common sense. 

 

Conversely, even if there are competing oligopolistic public service providers,  if there is no prescribed profit-rate limit, cartelized operation or regulatory capture can easily nullify the price-lowering effect of competition. 

 

 

 

Root of Lack of Enforced Rate-of-Return Limit:

Products of Local and Foreign Top Universities—

Dominant Free-Market Economists Unskilled in the Fine

Points of Properly Managing the Two Types of Market:

(1)   the Really Free Market for Thousands of Ordinary Goods

and Services, and (2) the Captive Markets for Relatively Few

Basic Necessities Clothed with Public Interest, to Which

the Power, Water, Telecom, and Toll-Road Markets Belong

 

From management audit standpoint, the Philippine economics “profession” has failed to help the government shape national economic policies and practices that spur economic development, promote equality and inclusive growth, maintain a fair balance between the conflicting interests of business and consumers, and bridge the gap between the poor and the rich.

 

Our abnormally high power rates, for example, have long served as obstacle to our industrialization and fast economic growth, yet our economists in and out of government have not offered the readily available solution that will definitely bring down our country’s second highest power rates in the region to reasonable level—strict enforcement of the Supreme-Court-ruled 12% rate-of-return limit, to be calculated based on net income before income tax (ERB vs. Meralco, G.R. No. 141314, November 15, 2002).

 

As explained further later, Meralco’s return on equity (ROE) as of 2015 stood at 31% before income tax and 24% after income tax, in violation of the Supreme Court ruling either way we look at it. Under the situation, if Meralco’s rate of return is adjusted downward to 12% as required by jurisprudence, its rates will definitely go down, so why is the Philippine economics “profession” deafeningly silent on it, despite my repeated emails to key members of it in the past?    

 

Thus, our high public service rates are caused by lack of properly enforced  rate-of-return ceiling, rooted in turn from the failure of the academe in the Philippines and abroad to produce Filipino economists who can distinguish between—and treat differently—the two types of market: the really free market for ordinary goods and services and captive market for basic necessities clothed with public interest. This problem stems from the dominance of free-market economists in the academe. They do not teach the fine points and applicability to crucial captive markets of regulation—probably because they are biased against it, they themselves were not taught about it in their student days in business schools, they are inexperienced on it, and they are simply not experts on it. 

 

The past oil industry regulation was conceptualized by one of my former immediate bosses, then Bureau of Energy Utilization Director Orlando L. Galang, a chemical engineer—not an economist—and alumnus of Texas A & M University, Under it, oil prices were limited to those that will yield rock bottom peso profit per liter of petroleum products sold. From it, I learned to appreciate the need for regulation in captive markets affected with public interest. I improved on what I saw in the past by espousing not peso-per-unit profit limit but percent rate-of-return ceiling. To my recollection, the oil industry—or at least Petron Corporation where I served as Controller before changing career to become a modest entrepreneur—was then earning way less than 8% return on equity. Now, under deregulation, we do not even know what rate of return the oil industry is earning, or whether it engages in overpricing or not—definitely not the proper way to manage the economy. 

 

 

 

What Competition as Price-Lowering Economic Tool

Has Failed to Do Indirectly in Deregulated WESM under

Fallacious EPIRA (RA 9136)—Bring Down High Power Rates—

Regulation with Proper Enforcement of Rate-of-Return Limit

Will Do Directly in the Power Generation Industry, and Such

Regulation Applies to Other Crucial Captive Markets as Well  

 

  “Economists firmly believe that voluntary transactions in free markets tend to work toward the common good. But they also believe that nearly every participant in the market place would love to rig the system in his or her own favor.”     [Sean Masaki Flynn, Economics for Dummies  (NJ: Wiley Publishing, Inc., 2005) p. 334]  

 

Therefore, instituting free-market COMPETITION under DEREGULATION does not always mean low prices, because profit-maximizing market players will instinctively work for more profits for as long as they can, as in the case especially of our ultra high medicine prices before the passage of the Cheaper Medicine Act in 2008 (RA 9502).  

 

As part of human nature and rapacious greed, despite presence of numerous suppliers, free market can yield high prices to the extent the MARKET CAN BEAR—without regard to actual low cost of goods sold by the  competing market players, an advantage that they keep to themselves and do not share as price reduction to consumers—for as long as there is opportunity for “every participant in the market place... to rig the system in his or her own favor.”

The government should be proactive, not reactive. It should plug vulnerabilities to, or opportunity for, market rigging. It should promptly institute the safety net against already existing—not just impending—unreasonable rates in the power, water, telecom, and probably other crucial captive markets:  reasonable cap in rate of return.      

 

 

Why Regulation of Captive Markets

Will Not be Unfair to Public Service Providers:

They Will Not be Forced Against their Will to Serve,

They Will Serve the Captive Markets, With Sure Demand

From Mass Consumers, Under Regulation Rules Set by

the Government Because it is Still More Profitable

for them to Do So Compared to Available Alternatives

 

In affirming its landmark decision that disallowed deduction from net income of corporate income tax in the reckoning of Meralco’s entitlement to 12% reasonable return (ERB vs. Meralco, G.R. No. 141314, November 15, 2002), upon Meralco’s appeal, the Supreme Court ruled further, as follows:

 

      “The business and operations of a public utility are imbued with public interest. In a very real sense, a public utility is engaged in public service—providing basic commodities and services indispensable to the interest of the general public. For this reason, a public utility submits to the regulation of government authorities and surrenders certain business prerogatives, including the amount of rates that may be charged by it.” (Republic of the Philippines, represented by Energy Regulatory Board vs. Manila Electric Company, G.R. No. 141314, April, 9, 2003).      

 

Therefore, in the privatization of government public-utility operations and awarding of franchises to public service companies, like those in the power, water, telecom, and toll-road industries, the government should set franchise or concession conditions protective of consumers and commuters, such as 12% or lower rate-of-return ceiling.

 

For as long as there are takers—which means that the government franchise or concession conditions are still more advantageous to private investors compared to their opportunity cost, the government should stick to those conditions. Only if there are no takers should the government sweeten the pot to attract investors.    

 

 

THE FUNDAMENTAL SOLUTION

TO OUR UNDULY HIGH PUBLIC SERVICE RATES

THAT HAS ELUDED FOR SO LONG OUR HIGHLY

EDUCATED ECONOMISTS AND FINANCE EXPERTS

IN AND OUT OF GOVERNMENT AND ACADEME:

 

PROPER ENFORCEMENT OF RATE-OF-RETURN  

CEILING TO PUBLIC SERVICE PROVIDERS—

THE SAFETY NET AGAINST OVERPRICING

 

There is a basic and common-sense solution that has been lacking and has seemingly eluded even our reputable economic and finance experts—proper enforcement of reasonable rate-of-return ceiling, which currently stands at 12% for public utility monopolies, as ruled by the Supreme Court in 1966 and reiterated in 2002 (ERB vs. Meralco, G.R. No. 141314, November 15, 2002). The lack of enforced rate-of-return ceiling stems from the following:  

 

1.    Lack of proper regulation of oligopolies in captive markets affected with public interest, such as those in the telecom industry,  followed by those in the power generation industry which have been deregulated under the Electric Power Industry Reform Act (EPIRA) of 2001 (RA 9136).   

 

2.    Lack of proper regulation of even the monopolies already subject to regulation pursuant to Section 19, Article XII of the Constitution—those operating in captive markets for public services clothed with public interest, such as in the power, water, and toll-road industries.

 

Following are the key performance indicators of lack of proper regulation of monopolies Meralco and Maynilad Water:  their excessively high rates of return on equity (ROE) based on their annual financial reports to stockholders and Securities and Exchange Commission (SEC):

 

     Meralco ROE:            Maynilad ROE: 

         2011:  20%                                2008:  247%

         2012:  25%                                2009:  147%

         2013:  23%                                2010:   82%

         2014:  23%                                2011:   59% 

         2015:  24%                                2012:   44%

 

The foregoing rates of ROE were calculated based on the conventional method of reckoning profit:  net income AFTER income tax. In the case of Meralco, if the rate of return is determined based on the Supreme Court ruling that disallowed INCOME TAX deduction in the reckoning of 12% reasonable rate of return, Meralco’s ROE based on net income BEFORE income tax is a whopping 31% in 2015! Is the Supreme Court ruling a joke that ERC and Meralco can make a mockery of it and violate it with impunity?      

 

 

 

PART II

HOW TO INSTITUTE PROPER

REGULATION OF CAPTIVE MARKETS

IMBUED WITH PUBLIC INTEREST

 

 

HOW TO ENFORCE RATE-OF-RETURN LIMIT

UNDER PROPER REGULATION OF MONOPOLIES

AND OLIGOPOLIES IN CAPTIVE MARKETS FOR BASIC

NECESSITIES AFFECTED WITH PUBLIC INTEREST

 

Under a system of fair and justifiable regulation, reasonable rate-of-return limit can—and should—be applied to all monopolistic and oligopolistic public service providers in captive markets clothed with public interest, including the power-generator oligopoly deregulated under EPIRA (RA 9136).

 

As Change for the Better

Under Privatization, Private Power Generators

Should be Subject to 12% Reasonable Return Limit

Allowed to Monopolies, or Preferably Lower; Allowing

them Higher Rate of Return Will Make Privatization

a Change from Bad to Worse, Not Change for the Better

 

If regulated monopolies like public utilities are entitled to 12% maximum return on investment (ROI) under a 1966 Supreme Court ruling on Meralco, reiterated in its landmark decision on Meralco corporate income tax (ERB vs, Meralco, G.R. NO. 141314, November 15, 2002), then as change for the better under EPIRA-mandated privatization, competing deregulated private generators should be entitled to less than 12% ROI, or at most equal to it, otherwise the change will be from bad to worse. 

 

Privatization in the power generation industry is a shift from regulated government monopoly without competition—the power-generator National Power Corporation (NAPOCOR)—to deregulated private oligopoly with supposed competition. It is intended to be a change for the better, from a monopoly without competitors to oligopoly with price-lowering competition.     

 

If so, as key performance indicator (KPI) of the change for the better, as regulated monopolies NAPOCOR and Meralco, as well as other public utility monopolies, are entitled to maximum 12% return on investment as ruled by the Supreme Court (ERB vs. Meralco, G.R. No. 141314, November 15, 2002), then—as proof of change for the better—the private oligopoly with competition should be entitled to return on investment lower than, or at most equal to, the 12% rate-of-return ceiling for the cited monopolies without competition—otherwise what is privatization with competition for?