Monday, 22 March 2010

Externalising the Internality

Back in August, I commented on a recommendation in the report of the Electricity Technical Advisory Group (ETAG) to force an asset swap between the two large SOE electricity generators, Meridian and Genesis. At the time, I thought that this swap was largely pointless (correcting a problem of market power that I don’t believe exists), but also would do little harm.

When the government announced plans for such a swap in December, it transpired that the particular asset swap would split up ownership of stations along a single waterway. The flow that is allowed through an upstream station can affect the production possibilities for downstream station. This is the classic kind of upstream/downstream issue that we use in undergraduate economics to illustrate production externalities. And the classic Coase-theorem-inspired solution to internalise the externality that we suggest in such cases is company mergers. To forcibly bring about the opposite would seem to be externalising the internality.

Recently, I discovered this paper, suggesting a number of reasons that asset swaps would actually worsen competition, even without any production externalities.

And now it transpires that Meridian have flipped and are now supporting the proposal. Does this mean that rather than increasing competition, Meridian and Genesis have found some way of using the new arrangement to extract some monopoly rents from the market? Or maybe the proposal has some general benefits that are not clear on the surface. I do wonder, however, if anyone has done any theoretical or empirical work to show a social benefit from an asset swap. If so, can anyone point me to it?

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