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Chapter 4: Fostering competition in product markets to boost productivity.

While significant advances have been made in strengthening product market competition in a number of areas, there is still considerable scope to enhance the role it can play in boosting productivity growth. Barriers to competition are still significant, including in sectors that produce intermediate goods and services, extending their negative impact on productivity throughout the economy. This chapter looks at the barriers to increased competition in goods and services markets and analyses the improvements introduced in recent years. These reforms concern sectoral aspects such as the regulation of network industries--in particular, the energy, telecommunications, transport and postal sectors, as well as other markets including savings banks, retail trade and the regulated liberal professions. Recent measures announced by the government, for instance in some network industries and in professional services, are a step in this direction.

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Trend productivity growth has been relatively weak in international comparison, even after accounting for compositional effects related to the unusually large construction sector. Over the past decade productivity advances appear to have been particularly meagre in international comparison in transport services as well as post and telecommunications (see Chapter 1). The government has recognised the important contribution that a competition-friendly regulatory framework can make to productivity performance and employment. Progress has been made across several policy areas, such as in some network industries, and a major reform of the competition law and enforcement system was implemented in the fall of 2007 (see the 2007 Economic Survey for details of the reform).

However, significant barriers to competition in some sectors remain. Raising competition in the network industries, as well as in the professional services, as could be achieved for example by some of the recent measures announced by the authorities, would have a "knock-on" effect throughout the economy, as they provide intermediate inputs to other sectors. Limited competition among suppliers may increase the cost of inputs and make the products supplied less innovative and of poorer quality, lowering productivity in downstream sectors. In addition, raising the intensity of competition in retail trade could help contain inflation, strengthening competitiveness in sectors producing internationally tradable goods and services. Recent OECD empirical analysis shows that competition-restraining regulations slow the rate of catch-up with the technological frontier, where labour productivity is the highest (Conway and Nicoletti, 2006; OECD, 2007d). This chapter suggests reforms designed to enhance competition and to improve product market regulation in order to enhance productivity performance.

There is considerable room to strengthen the sectoral regulators

While sector-specific regulators exist in the majority of the network industries, in some cases the independence from the government is relatively weak. In the railways sector, the regulator is an internal department within the Ministry of Public Works, although an overhaul of the regulator is under discussion. The terms of office of senior regulatory appointees are typically limited to six years, and reappointment for an additional term is possible, tending to limit their independence. The powers of the regulators are less well developed than in other OECD countries, making it more difficult to prevent market incumbents from using their market power to restrict entry. For instance, the Spanish energy regulator (CNE) lacks the authority to set network access tariffs, as its duties are restricted to submitting a report to the Ministry of Industry, which has the final say. In addition, the Ministry can revoke the CNE's decisions. In some industries, an independent regulator has yet to be created--in the water distribution and airport sectors, for example. Another weakness is that, in general, while regulators can be obliged to appear before Parliament, their regular appearance is not mandated.

Strengthening the independence and providing sufficient powers for network regulators can help ensure that potential market entrants perceive regulation to be neutral and predictable, facilitating their entry and making it more credible. This, in turn, will discipline price-setting behaviour by incumbents. There is some consensus on what institutional characteristics are most conducive to strong regulators (see OECD, 2005 and Smith, 2007). First, regulators should have an arm's-length relationship with regulated firms, consumers and other private interests in order to take decisions related to pricing and access to infrastructure free from interference. Second, they should also have an arm's-length relationship with political authorities so as to avoid perceptions by market entrants that the government may be acting in the interest of the incumbents. Restricting regulators to a single term in office reduces the scope for them to be influenced by government officials, particularly when the term is about to expire. The regulators' decisions should be final and not be overturned by other offices. Third, regulators should be granted all of the attributes of organisational autonomy necessary to foster the requisite expertise and to underpin those arm's-length relationships. Fourth, they should be accountable not just to Ministers but also to Parliament and to interest groups with a duty to explain decisions clearly and transparently. Increasing the accountability of regulators provides legitimacy and credibility to regulatory activities, promotes public confidence in the regulator and ensures that regulatory decisions can withstand challenges and public and governmental scrutiny. The Government has committed to present a proposal by 2009 to increase the independence, supervisory powers and accountability of sectoral regulators. Some of the changes needed could be modelled after the reform of the competition authority, whose independence was raised in 2007.

The regulatory framework of the electricity market has been significantly improved

Spain's electricity market was liberalised in 1998 and has recently been the centre of intense debate mainly because of concern about the possibility of increases in retail prices. Although international price comparisons must be interpreted with care, as price differences reflect other factors besides differences in the degree of market liberalisation or competition, retail prices for households appear to be relatively high (Figure 4.1) in Spain, notwithstanding the fact that they remain heavily regulated (see below). Significant changes in the regulatory framework are expected to become effective from 2009 onwards, improving the prospects for effective competition. However, there is still room for further improvements.

Interconnections with other countries remain few, but significant entry in generation has occurred

The electricity market is not sufficiently open to the outside world, which limits competitive pressures. Although interconnection capacity with Portugal has increased, it is still subject to congestion. Trade with France remains extremely limited, accounting for less than 3% of energy demand, and existing interconnections are heavily congested (European Commission, 2007). Although two vertically integrated firms (Endesa and Iberdrola) (1) account for almost half of electricity generation, their shares have decreased substantially since liberalisation. In addition, there has been significant market entry. Gas Natural, the incumbent in the gas market, and other international firms have invested in natural gas combined-cycle plants. In addition, firms in the renewable-energies special regime now account for around 12% of total electricity generation. Ownership separation of the electricity transmission network from competitive activities is likely to have supported entry, removing incentives to discriminate against entrants. There is, however, agreement among market participants that the authorisation process to build new power plants is long and cumbersome, and can be a significant barrier to further entry (Perez-Arriaga, 2005). There is a large number of agencies at every level of government that are involved in the authorisation process, a heterogeneous group of entities that can lead to duplication in some cases. In addition, the lack of independence of the regulator (as discussed above) might also hamper new entrants' confidence in having a level playing field with incumbents.

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New futures trading and medium- and long-term electricity contracts have recently been introduced, although they are still not widely used, as most transactions are done on the spot market, with prices and quantities determined through a uniform price auction. International evidence suggests that spot electricity markets, even in cases where supply is sufficiently fragmented, are prone to manipulation, especially in peak periods when generators can increase prices without losing market shares (Beato and Delgado, 2007). In addition, the use of medium-term contracts improves competition in the spot market, as the quantity offered by the supplier in that market, and hence the potential benefits of increasing prices above costs, is reduced (Newbery, 1998). (2) Lastly, the resulting lower uncertainty about price fluctuations can encourage more capital investments.

Regulated retail prices have distorted the market

Retail electricity prices are regulated by the government and are set without fully taking into account the actual evolution of the cost of energy, generating a substantial deficit (around 3 billion [euro] in 2006 and 1.2 billion [euro] in 2007). The deficit is covered by bonds issued by distributors and will be recovered through a surcharge in the (regulated) access tariff (Vives, 2006). In this way, retail distributors receive the full market price for electricity, but tomorrow's consumers will pay higher prices to pay down the accumulated deficit. The low pass-through of electricity costs into retail prices makes final demand less sensitive to changes in such costs and is a reason behind Spain's overshooting of previously set greenhouse gas emissions targets (see below).

Retail prices are further distorted by the mechanism of capacity payments made to generators as a reward for their contribution to the reliability of the power system (Fabra, 2006). A surcharge on retail prices is set by the authorities, and the collected funds (amounting to around 1 billion [euro] in 2006) are distributed amongst providers based on the time they are available to increase production. However, firms receiving the payment are under almost no obligation to actually increase capacity. For instance, if a generator is not available at a moment when needed, it forgoes the capacity payment for that day (a relatively small sum) but is still entitled to receive payments for the rest of the year (Perez-Arriaga, 2006). Hence, at present, capacity payments are still not sufficiently linked to the use of capacity when capacity utilisation is high, but rather they are linked to the existence of spare capacity. Spare capacity can, in turn, create an entry barrier, since it creates a threat to bring it on stream to lower market prices in case of new entry. The authorities are working to introduce a variable payment that will be linked to the actual use of capacity at peak times.

The authorities have acted on several fronts

Several improvements to the market have recently been made. First, interconnection with Portugal has increased since the Iberian electricity market (MIBEL), an integrated wholesale market, was established in 2006. A single market operator was created, and a common price for electricity for both countries is now set if the interconnection capacity allows it. In addition, efforts are being made in order to harmonise regulation between the two countries. There is still scope, however, to increase interconnection capacity, especially in order to benefit from additional investments in generation that are planned in Portugal, which will increase production at a faster rate than the expected increase in domestic demand (OECD, 2008a). In June 2008, the governments of Spain and France agreed to build a new interconnection grid that is estimated to increase the interconnection capacity to 5% of peak demand in 2011.

Second, as in several other OECD countries (for instance, Belgium, Canada, France and the Netherlands), a virtual power plant scheme was introduced in 2008 through which Iberdrola and Endesa are obliged to auction off a share of their existing generating capacity to other firms. The winner of the auction acquires an option to purchase electricity (whether at peak or base hours) at a predetermined strike price, up to the capacity that they have paid for. The authorities aim to increase competition in generation activities, by helping to develop forward electricity markets, increasing the liquidity of long-term markets and decreasing the importance of the spot market (Perez-Arriaga, 2005).

Last, a new law regulating the electricity sector was adopted in 2007, including several welcome changes to the way that regulated retail electricity prices are set. All suppliers to the regulated market are now able to acquire energy through auctions of medium-term (three months) bilateral contracts with generators. The price of electricity resulting from the auction is then fully reflected in the regulated retail price, which can be updated on a quarterly basis. This has somewhat reduced the distorting effect of regulated retail prices. The subsidy needed to cover the difference between the regulated retail price and production costs resulting from a too-low tariff is allocated to the regulated activities, through lower access tariffs. In this way, retail prices net of transport costs reflect the actual costs of electricity, eliminating distortions in competition (3). In addition, most regulated high-voltage retail prices were suppressed in July 2008 and regulated retail prices will be limited to a maximum price for low-voltage customers (both households and small firms) by 2011. Allocating powers to set retail prices to the ministry entails risks that such prices would continue not to be sufficient to cover costs because of political pressures. As retail prices for low-voltage consumers remain heavily subsidised, 52% of the total electricity consumption is purchased in the regulated market, and switching providers is practically nonexistent. The creation of a new office (in August 2008), in charge of overseeing and regulating customer switching in the gas and electricity markets, could make switching easier for consumers by providing adequate information about prices, and providing and enforcing a clear set of rules.

More can be done to increase competition

Further reform efforts should focus on providing the necessary means for the market to work properly and to restore the central role of market prices in determining production and investment decisions. In light of the phasing out of regulated tariffs, it is particularly important that interconnections with both France and Portugal be increased as planned and that remaining entry barriers be dismantled. This could be accomplished by streamlining the authorisation process of new power plants by grouping all procedures into a single process ("one-stop shop"), formally setting the co-ordination mechanisms among the interested entities, and increasing the human and technical resources in charge of processing the applications. In addition, increasing the independence of the regulator (as discussed above) would increase new entrants' confidence in having a level playing field with incumbents. Regulated retail prices should be eliminated as soon as possible, and support to low-income households should be offered via means-tested cash transfers. If regulated prices cannot be eliminated for all consumers, then the regulator should be entrusted to determine them. In addition, the regulator should determine the access tariffs to the distribution network. It is important to reward adequately stand-by capacity in order to avoid under-provision at peak times. To achieve this, the current system of capacity payments should be enhanced with a more direct link between the payments and the use of capacity when capacity utilisation is high, instead of linking payments to the existence of spare capacity, as planned by the authorities.

Competition has increased in the market for natural gas

The natural gas market in Spain is relatively recent and has been growing strongly, in particular due to increased combined cycle generation in the electricity sector. The market has achieved a high degree of effective competition (Bel et al., 2006; European Commission, 2007b) after it was further liberalised in mid-2007, when a new law was adopted that implemented the elements of the European Directive on the internal gas market not yet contained in previous legislation. The new law limits regulated retail prices to households and small business customers (the so-called tarifa de ultimo recurso) and mandates the functional separation of transport from retail distribution activities of firms that also have trading activities. The transmission system operator, Enagas, is fully ownership unbundled, and there is agreement among market players that access conditions to the grid have improved considerably in recent years. The market share of the incumbent (Gas Natural) has fallen to below 45%, and there has been considerable market entry--by large electricity-generating companies, including from abroad. Retail prices remain close to the OECD average, both for households and industry (see Table 4.1), however, price differences across countries may not only reflect different degrees of competition. As in the case of the electricity market, consumers can freely choose their suppliers. Market liberalisation has progressed more rapidly in the natural gas market, with 95% of total consumption purchased in the liberalised market. Switching appears to be almost nonexistent, although the creation of the office to oversee customer switching may help raise it. Abandoning the regulated tariffs should be considered, relying instead on prices that adequately reflect the various cost components and providing support to the less well-off by a system of targeted cash transfers.

Additional efforts to reduce greenhouse gas emissions are needed

The government remains fully committed to reducing the country's greenhouse gas emissions (GHGs) and the strategy can also benefit the Spanish economy. Preliminary data suggest that GHG emissions reversed their trend growth in 2006 and 2007, falling by around 4 percentage points from 2005. This fall was mostly the result of the high level of emissions in 2005, which was mostly due to the severe drought that cut hydroelectric power generation by 40%, the latter having to be replaced by supplies from emissions-intensive sources. However, GHG emissions remain close to 50% higher than the base year (1990), and Spain is one of the OECD countries furthest away from reaching its Kyoto target, although emissions per capita remain below the OECD average. In light of the difficulty of reaching the domestic target set in 2005 of a 24% increase over the 1990 level of GHG emissions for 2008-12, the government raised the target to 37%. (4)

The new target is, however, still close to 13 percentage points below projected levels. Indeed, the latest official projections (submitted to the European Commission in December 2007) suggest that, with no additional polices, emissions will stabilise at close to 50% above their 1990 level. Hence, in order to reach the GHG target for the period 2008-12, emissions will need to be reduced by around 27 million tons of CO2 per year. (5) The central government has implemented a number of measures intended to reduce emissions by around half this amount, among them, exempting low-emission vehicles from payment of the vehicle-registration fee and charging higher fees to high-emission vehicles, as well as measures to reduce energy consumption in public buildings. In addition, an ambitious national target to increase the use of renewable sources to 12% of total energy consumption and 29% of electricity consumption by 2010 was adopted. The number of emission allowances allocated under the European Directive will be reduced by 16.2% (compared with the 200507 period). Permits were assigned directly to firms for free, based on a benchmarking system using as a point of reference the cleanest production technology available in each sector.

Selling C[O.sub.2] emission permits through an auction mechanism instead would help attain environmental targets at lower efficiency cost to the economy, for two reasons. First, it is difficult to avoid linking the allocation of pollution permits to emissions-generating activity. Therefore, to the extent that agents can anticipate future permit allocation rules, incentives to abate pollution may be reduced and non-viable incumbent firms may have incentives to stay in business to receive free emissions permits. Second, selling all of the permits to be assigned through an auction mechanism would help reduce government debt by close to 0.4% of GDP per year without resorting to distortionary taxation. Moreover, a well-designed C[O.sub.2] permit scheme generates marginal opportunity costs in the emission of C[O.sub.2], regardless of whether the permits are auctioned or allocated for free-the latter is just a problem of distribution of economic rents. C[O.sub.2] emission permits should be sold through auctions. EU rules applying to the current permit allocation plan only allow the sale of up to 10% of the permits. Spain should also use its influence to eliminate this cap.

A feed-in tariff regime (called the special regime) has been in place for renewable sources of electricity since 1997. The owners of the distribution networks are obliged to purchase all the electricity supplied by companies in the special regime, which in effect, therefore, face a perfectly elastic demand. Special-regime companies can also decide to take part in the wholesale market, where they receive a premium over the market price. Either way, the goal is to reward energy produced from renewable sources at a price that guarantees the generating facilities are run profitably. The premium is payable over the complete useful life of the asset used in generation, in contrast to other countries where eligibility is set at a fixed number of years. The tariffs are recouped through a surcharge on consumers' electricity bills that is proportional to their overall electricity consumption. The main justification for the special regime is that it can internalise the marginal social benefits in the form of the environmental advantages of renewable energy. While the special regime has been successful in increasing the supply of renewable energy, the existing evidence suggests this is not the most cost-effective solution to curbing GHG emissions (OECD, 2004). Thus, in order to assess the effectiveness of the special regime, more studies on cost effectiveness and, in particular, comparisons with other abatement methods are needed.

The telecommunications market has become more open to competition

Competition is strong in the fixed and mobile telephony markets

The telecommunications sector continues to grow at a healthy pace, supported by some improvements to the regulatory framework that have stimulated competition. Competition is vigorous in voice services, with mobile telephony accounting for more than 45% of all voice traffic (Comision del Mercado de las Telecomunicaciones, 2007). Significant market entry has occurred, with seven new entrants launching mobile services in 2007. Number portability is among the highest in the EU for mobile (13.4 million) and fixed line (3 million) numbers, which demonstrates that it is not costly for customers to switch providers.

The incumbent maintains a strong position in the broadband market and is laying out a new fibre network

The broadband Internet market is on a dynamic growth trajectory. ADSL lines account for almost 75% of broadband access lines, while cable access has reached a market share of 20%. Recently, local loop unbundling (LLU) has overtaken bitstream access to become the main means of access, after cable, for alternative operators. The increase in the number of unbundled lines in the local loop suggests some improvement has taken place in the unbundling process, and average retail prices have recently fallen to international levels. However, according to a study done by the regulator (CMT), the prices charged by the incumbent (Telefonica) are above those of incumbents in other countries and are also higher than those of its competitors (Figure 4.2). Moreover, information from the European Commission suggests that Telefonica's market share remains high, at around 55%. In addition, while broadband penetration has increased, it is, at around 19 subscribers per 100 inhabitants, still significantly below best-performing countries. Telefonica has announced plans to lay down a new fibre-optic network with a total investment of around 1 billion [euro] between 2007 and 2010 and is still carrying out trials of both VDSL and fibre to the home (FTTH) technologies. Different technologies in fibre networks have vastly different implications for competition, in particular as regards the possibility of allowing different operators to access the new network (Box 4.1).

[FIGURE 4.2 OMITTED]

The regulator has been active in ensuring fair access to the incumbent's network ...

Significant efforts have been made by the authorities to improve protection of users' fights and quality of service information, with the creation of a dedicated office to protect telecommunications consumers, and the creation of a webpage where users can compare offers from different providers. In addition, a new charter of consumer fights is expected to be in place before the end of 2008. The CMT, who appears to have more independence and regulatory powers than the other regulators in Spain, has resolved access disputes and breaches of LLU obligations. Over the past year, the CMT established that Telefonica voluntarily obstructed the provision of LLU services by alternative operators in a continuous and generalised manner and imposed fines totalling more than 41 million [euro]. It has also resolved a number of access and quality-of-service disputes and worked to streamline unbundling requests and procedures. In addition, the European Commission ruled that Telefonica's wholesale prices (which were authorised by the CMT) were excessively high and fined it more than 150 million [euro]. Both the government of Spain and the CMT have appealed the European Commission's ruling, arguing that the fact that the CMT's resolutions have been struck down due to a posterior decision of the Commission generates judicial uncertainty. In addition, the government claims that the Commission's ruling is based on an inaccurate analysis of the market. The appeal is not likely to be settled until sometime next year.

... and has published the guidelines for the regulation of next-generation networks

The CMT has been one of the first European regulators to publish a document, in January 2008, that outlines the main features of future regulation of Next Generation Networks (NGAs), including in particular fibre-optic networks. The document reflects a process of public consultation and aims to provide a consistent and reliable legal framework for all operators and promote infrastructure-based competition (Comision del Mercado de las Telecomunicaciones, 2008). The existing regulatory framework of the legacy copper network will be maintained--current access obligations to alternative operators will remain as long as any part of the copper network is used. A market analysis will be done to determine whether markets need to be separated into competitive and noncompetitive segments, which can be subjected to different regulatory obligations. In areas that are deemed to be non-competitive, the operators will be required to provide wholesale access (bitstream) only as long as broadband services cannot be provided by competitors. In areas that are declared to be competitive, wholesale access will be mandated only for a specified period of time. In all areas, operators who roll out fibre to the home (FTTH) networks will not be required to provide full unbundling. More recently, the CMT published a set of regulatory measures that will be in place until the full regulatory framework of NGAs is completed, in order to reduce Telefonica's first-mover advantage when laying down the new network. Among other measures, the CMT has mandated Telefonica to offer access to civil works infrastructure on transparent and non-discriminatory terms. This is important as civil works are a significant part of the total costs of rolling out a new network. The current local-loop unbundling obligations might adequately protect alternative operators' investments in Telefonica's exchanges from the risk of closure. However, it is to be expected that some of the exchanges will become obsolete once the new fibre network is rolled-out. Telefonica will be allowed to dismantle them under certain conditions to be determined by the new regulatory framework.
Box 4.1. Next generation networks

The emergence of new services that are provided over the internet,
such as high-definition TV or video conferences among others, is
likely to increase the demand for transmission capacity to at least
50Mbit per second. In order to increase available capacity to
satisfy new demands, significant investments will be needed in
order to develop Next Generation Networks (NGN) that bring fibre
optic networks closer to end users. There are a number of different
configurations for the roll-out of a NGN, and their implications
for the future development of competition in access markets can be
vastly different.

In a fibre to the home (FTTH) network, a fibre optic cable reaches
the customer's house or building. There are two basic
configurations of a FTTH network. In a point-to-point (P2P) FTTH
network, a single fibre cable is run directly from the central
offices to the customer's premises. This is generally regarded as
the most competition-friendly network, as full unbundling is easy
and inexpensive. While the roll-out costs of such a network are
high, some operators believe that in the long term they may be more
cost-effective (OECD, 2007a). In a passive optical network (PON)
FTTH, a fibre cable from the central offices is split into
individual fibres that are run directly into the customer's
premises. If the fibre is split close to the customer, it is only
possible to unbundle all of the homes that use a fibre together The
fibre can also be split at a street cabinet, and in this case
unbundling can take place at the street cabinet for individual
houses (OECD, 2007b).

As an alternative to FTTH, some operators are investing in fibre to
the node (FTTN) networks, where the fibre reaches a street cabinet,
where VDSL technology is used on the existing copper loop to the
house or building. This requires the installation of street
cabinets close to the customer premises--in order to deliver
adequate speeds (of around 50Mbit/s), they should be placed no more
than about 450 meters away from the customer. Providing direct
access through full unbundling of a FTTN is possible, although it
faces several difficulties. First, alternative operators will need
to invest significant resources in order to place their equipment
in the street cabinets. Second, street cabinets require substantial
space, and this may result in local governments and citizens
objecting to the placement of multiple street cabinets in the same
location. Third, a FTTN can be deployed relatively quickly, and can
give the operator a first-mover advantage over other potential
competitors.

Maintaining unbundling as the cornerstone of regulation might not
be feasible if, for technical and/or economic reasons, unbundling
is not possible. Since it is not desirable to mandate the network
topology chosen by a firm with an existing dominant position in the
fixed access market should allow for unbundling, the main barriers
to market entry policy makers need to address in the roll-out of
fibre are likely to be returns to scale in civil works and access
to homes/buildings (OECD, 2007a). Construction costs are likely to
account for up to 80% of total costs in rolling out a FTTH network,
and incumbents have a significant advantage because their
historical monopoly position has given them existing rights of way,
and they usually own the ducts used by copper networks (which often
means they do not pay for rights of way). The main ex ante
regulations needed to reduce bottlenecks include ensuring access to
rights of way for new entrants and incumbents; allowing new
entrants to access existing civil works of both network operators
and utility companies and municipalities; regulations to ensure the
sharing of access to the inside wiring of apartment buildings and
homes; and facilitate access to street cabinets.

Where adequate facilities-based competition is not viable,
wholesale access (bitstream) policies need to be applied to new
fibre networks (OECD, 2008b), and the regulator should ensure that
it is provided on a non-discriminatory basis.


Further reforms are needed to ensure vibrant competition in a changing landscape

In a rapidly growing broadband market like Spain's, where each year around 1.5 million new customers enter the market, the fact that the incumbent has been able to increase its market share while offering its services at higher prices might reflect problems in the wholesale access market. Past breaches of local loop unbundling obligations by Telefonica, even if they have been corrected by the CMT's actions, might have created a lasting public impression of bad quality of service from alternative operators. This could explain customers' reluctance to leave the incumbent for more attractive offers from alternative operators. The regulator should make sure that the combination of Telefonica's high prices and elevated market share in the broadband market are not due to a lack of competition in the wholesale access market.

The deployment of NGA networks is posing new challenges to the regulatory framework, as in other countries. The CMT is to be commended for taking early steps by publishing the guidelines for the regulation of the NGAs. The main risk posed by the deployment of NGAs is that infrastructure-based competition fails to materialise, leading to a situation where the incumbent regains a dominant position in the wholesale market. This could be extremely difficult to correct ex post through regulatory measures--as discussed above, unbundling procedures can be very difficult under some network architectures and wholesale access could be the sole source of competition. In this case, to prevent discrimination against alternative operators using wholesale access, some separation requirements are likely to be necessary between network access services and competitive retail services. Currently, the CMT does not have the explicit power to mandate the functional separation of the incumbent. However, it could do so, as it is authorised to take extraordinary measures in order to safeguard competition in the telecommunications market, but such a move would need to be approved by the European Commission. As both the Competition Authority and the European Commission have recommended, the CMT should be granted, as a measure of last resort, the explicit power to implement the functional separation of the incumbent. Future regulation should ensure that sufficient notice be given to alternative operators when the incumbent plans to shut down exchanges. The current norms regarding common telecom infrastructures inside shared premises do not cover fibre and do not apply to older buildings. They should be updated.

Rail and road freight transport should be opened fully to competition

Regulation of the rail market is restrictive in international comparison (Figure 4.3). The new Railroad Law, which was approved in 2003 but only fully implemented in 2005, introduced managerial and legal separation between network management and transport activities, as required by EU law. The former operator, Renfe, was split into two independent, state-owned companies--Renfe (Renfe-Operadora), the transporter, and ADIF (Administrador de Infraestructuras Ferroviarias), the new agency for rail infrastructure management (see Barea et al., 2007). (6) The local and international freight transport market was subsequently liberalised, and private companies have already been granted operating licences to compete with Renfe, although their market share remains small (Campos, 2008). Liberalisation of the passenger segment of the market will be delayed at least until 2010--until that time Renfe will remain the sole passenger operator.

[FIGURE 4.3 OMITTED]

A new regulatory body, the Railway Regulation Committee, was created as part of the Ministry of Public Works and charged with granting licences and with overseeing the two public companies. The authorities have announced plans for a reform to strengthen the independence (as required by EU directives) and expand the responsibilities and tasks of the industry regulator, which remain limited. The introduction of competition in passenger transport could be brought forward, for example by putting the operation of regional passenger services out to tender on a compulsory and regular basis, as other OECD countries already do or are considering doing. The experience of OECD countries in liberalising passenger transport services suggests that incumbents typically have an effective monopoly over rolling stock, as technical requirements on rolling stock are different across countries and tendered service contracts are relatively short term (Hoj et al., 2007). Hence, the incumbent should be required to make its rolling stock available on non-discriminatory terms and conditions.

Restrictions to entry and consolidation in the road transport sector should be abolished

More than 95% of internal transport of merchandise is done by road, a share that is much higher than the average in the European Union, reflecting still modest development of the railway infrastructure (OECD, 2007c). The requirements to obtain an operating license for the transport of heavy merchandise seem excessive, as the Competition Authority has previously observed (Tribunal de Defensa de la Competencia, 2005), and are more restrictive than those in Spain's main partner countries and seem disproportionate. They are likely to restrict the entry of new competitors in this market. In addition, it could make reorganisation efforts and capacity reductions more difficult (Comision Nacional de la Competencia, 2008). Hence, the constraints involved in obtaining a road freight haulage operating license should be abolished, and the authorisation process should be reformed in order to make consolidation of firms easier. A recent report by the competition authority (Comision Nacional de la Competencia, 2008) found that the tender of transport licences favours incumbents. In the near future, the government will begin the process of renewing road passenger transport licenses. When it does so, it should ensure that these licenses are tendered on a competitive basis without favouring incumbents.

The postal market has been opened up to competition

The postal market in Spain has been liberalised, and a number of alternative operators have entered the market, although their market shares remain limited. The universal service provider (Correos), a publicly owned corporation, retains a market share of around 90% of domestic deliveries. As in other European countries, in Spain Correos is granted an exclusive right to conduct a business for collection, transport and delivery of letters and other items under 50 grammes. Intra-city mail is excluded, however, and the delivery of direct publicity has also been liberalised. Overall, the practical effect of the remaining legally-guaranteed monopoly appears to be relatively small compared to the postal monopolies in other European countries and this reserved area will disappear when the market is fully liberalised in 2011.

Access to the postal network can be improved

The public postal network (PPN) is a vast network of physical and informational resources, including for example the final delivery of letters, that is subject to natural monopoly conditions and is owned and operated by Correos. Since late 2006, competitors can access the PPN on terms that are negotiated on an individual basis with Correos. The regulator acts as a mediator in case the parties cannot come to an agreement. Access to the network can ensure the benefits of the economies of scale are shared between all the market participants, allowing alternative operators to compete with Correos in the market segments that have been liberalised. Establishing ex ante price-cap regulation, by fixing prices several years in advance, could decrease uncertainty about access to the networks and could also help to lower access prices in an efficient manner. The new independent postal regulator, which is expected to be in place in late 2008, should be charged with the enforcement of this regulation. In addition, access to the database of valid physical addresses and address changes is not guaranteed to alternative operators. A consensus seems to be emerging among European countries that the regulator should ensure an appropriate level of access of competitors to the downstream services of the universal service providers, in particular address databases (PricewaterhouseCoopers, 2007).

Savings banks should be more exposed to market mechanisms

One of the main features of the Spanish banking sector is the coexistence of two major distinct groups, the (originally regional) savings banks (Cajas de Ahorro) and commercial banks, both of which are equally subject to the supervision of the Bank of Spain. (7) While savings banks also exist in a number of other OECD countries, what stands out in Spain is the fact that savings banks as a group have steadily increased their market shares, rivalling commercial banks, and even attaining dominance in certain segments of the market. Although they lag the commercial banks significantly in expanding internationally, they have grown outside their regions of origin, with several Cajas now having national networks. As a sector, they have been highly profitable and have expanded significantly in the residential construction sector: by the end of 2007, their share of the residential mortgage market was 57%, and lending to property developers has also been substantial (see Chapter 1).

The Cajas have a particular legal status--they are "not-for-profit foundations" and are, in effect, ownerless. Their governance structure is such that those exercising control and taking operating decisions are not the legal owners. On the one hand, they are financial institutions that function in the market economy; on the other, they are foundations that are exposed to political influence by political entities, in particular local and regional governments. Reflecting their origin as foundations, they devote a significant share of their profits (around 25% in recent years) to social spending.

Regional and local governments can exert influence through direct participation in governing bodies ...

Public-sector entities can exert some political influence over the Cajas' business decisions. (8) They can do so through their direct representation in the fundamental administrative body, the General Assembly, which is typically composed of elected representatives of founders, local and regional authorities, depositors, employees and other groups. New legislation in 2002 took a first step to mitigate this political influence. In that year, the national ceiling (9) on the share of public representation in the General Assembly was lowered to 50% (Boix and Urena, 2006), (10) and the average share of public representation among all Cajas was reduced from 48.5% to 42.3% between 2002 and 2005. Additionally, the mandate of its members during their terms of office was made irrevocable and prolonged from four to six years, thus decoupling political cycles from the Cajas' management terms. Scope remains to insulate the Cajas from political influence, for instance, by further lowering the public sector representative ceiling.

... and through regulation

On the basis of a national framework, the autonomous communities can adapt the rules of the Cajas, in a variety of ways. For instance, mergers by Cajas from different regions need to be approved by both autonomous communities because they need to agree on the distribution of the public-sector representatives in the General Assembly of the new entity's board. This can prevent mergers across regions when they might be economically advantageous. Another source of concern, which similarly arises in public-sector banks in other countries, lies in their industrial holdings. While they remain a smaller share of assets than in the case of commercial banks, there is a risk that conflicts of interest are generated if autonomous communities acquire some control over private firms, even if only indirectly, when, at the same time, they are subject to regional regulation.

Limitations to outside equity raises problems

To raise outside capital, Cajas can issue only the so-called Cuotas Participativas, which in essence are non-voting equity securities. The Cajas can also issue preferential shares and subordinated debt which is redeemable and must be remunerated and therefore belongs to tier II capital. The Cuotas Participatiuas issued must not exceed 50% of the value of tier I capital, and no individual investor may acquire more than 5% of the units issued, in effect limiting investors to holding no more than 2.5% of a savings bank's equity. An additional element that might make the Cuotas Participativas less attractive to investors is the fact that the General Assembly has a degree of latitude to decide the size of the payout attributable to the Cuotas Participativas, yet the bearers have no voting rights in the General Assembly. The conditions may be sufficiently restrictive to make it unlikely that investors will find them attractive in case of financial difficulties of issuers (Deutsche Bank, 2004b and Berges and Garcia, 2007). Some Cajas have recently announced plans to issue Cuotas Participatiuas, and the first Caja to use this instrument since its introduction in 2002 raised 300 million [euro] in 2008. Preferential shares are limited to 30% of tier I capital. Unlike the cuotas participativas they can generally be redeemed (subject to approval by the Bank of Spain) after a period of five years. They also yield a return as determined prior to the issue (which may, for example, be indexed to market interest rates), although it is conditional on positive profits. While they are classified as tier I capital, they are, therefore, considered to be a less reliable source of funds than the cuotas participativas (Berges and Garcia, 2007). Moreover, there is no possibility of being taken over by other institutions, with the exception of other Cajas, and this is not a straightforward process, as discussed above. If a Caja found itself in financial trouble, the limits to accessing outside funds would prove disadvantageous, as they could reinforce pro-cyclical lending policies, as a Caja would, in such an event, be more likely to restrict lending to raise the amount of capital relative to the value of assets and could slow any needed recapitalisation, and potentially raise the need for public funds in such a process.

Further reforms are needed

The regulation of the Cuotas Participativas should be reformed in order to make them more attractive to investors. The requirement for regional governments to approve mergers of Cajas should be eliminated and should be subject only to approval by the Bank of Spain and the national competition authority. To simplify such mergers, the division of public-sector representation of the regions represented in the savings banks to be merged could be determined ex ante. The ceiling on public-sector representation in the General Assembly should be lowered significantly, and the selection of management on the basis of professional criteria be strengthened, for example by introducing an independent selection panel.

Existing restrictions to retail trade should be dismantled

The retail distribution sector benefits from economies of scale and scope, and in many countries this is manifest in the ongoing process of structural change involving larger retail outlets, consolidation into retail chains and greater concentration and vertical integration. It is the main connection between manufacturers and consumers, and it is where final consumer prices are determined. An efficient distribution sector disciplines costs in the upstream wholesale sector, where productivity growth has been low in international comparison, and gives consumers access to a wide variety of goods at competitive prices. An efficient regulatory regime in this sector is therefore crucial for overall economic performance (Hoj et al., 2007).

There is evidence to suggest that retail regulations in Spain are rigid by international comparison (Figure 4.4). They may even have become tighter in recent years, in part due to increasing regulatory powers of regional and local governments, who are likely to be less inclined to grant planning permission to large retail outlets, possibly because they are more subject to pressures from incumbents. Freedom to set shop-opening hours, a competence of autonomous communities, was reduced for large establishments, and restrictions for hypermarkets remain rigid. These trading restrictions are in part meant to achieve social objectives such as protecting workers from unattractive work hours. However, they are also meant to safeguard local establishments by restricting the entry of new firms, thus impeding efficiency gains.

[FIGURE 4.4 OMITTED]

Recent evidence suggests that less restrictive regulations in the retail sector are associated with positive effects on sectoral efficiency and employment (Hoj et al., 2007). Judicious reductions in restrictions on trade in distribution services can improve competition and efficiency, and reduce the prices paid by the final consumer. Cost reductions resulting from easing restrictions in large outlets have had a measurable impact on consumer price inflation in the Czech Republic, for example. The new European Services Directive is aimed at creating a single market for services, principally by doing away with unwarranted service industry regulations (European Commission, 2007a). The transposition of the Directive is an opportunity to dismantle regional barriers to trade in Spain. In particular, the authorities should make sure that, as they have already announced, the transposition of the Directive is done in an ambitious manner. In any event, the central government should take resolute action to reduce the variety of different regional regulations in cases not covered by the Directive, for example in the regulation of professional services (see below).

The regulation of professional services should be revised

In OECD countries, professional services are generally subject to pervasive regulation including, among others, as regards entry, access and residency requirements, regulated prices and the exclusive exercise of certain functions (see Hoj et al., 2007). Although these regulations could in principle lead to improvements in service quality and prevent market failure, empirical evidence suggests that the associated restrictions lead to higher prices and less innovation, without improving quality (Nguyen-Hong, 2000; Paterson et al., 2007).

In international comparison, the regulation of professional services in Spain does not seem to be particularly restrictive overall (Figure 4.5). However, it is among the countries with the highest number of regulations that restrict professional activities to holders of specific academic or professional degrees--a total of 122 regulated professions, without considering health services and architecture. Of these, there are 22 professions that are not regulated in any other EU15 countries besides Spain, (11) and 60 professions are regulated in no more than five other countries. The regulation of lawyers is the fourth most restrictive in the EU15 (Table 4.2). In addition, the proliferation of new regional professional associations, which are involved in regulation threatens to limit the scope of national licensing systems and creates incentives for them to increase entry barriers, which might also result in lower geographical mobility of workers within Spain (see Chapter 2). As pointed out in a recent report by the competition authority (Comision Nacional de la Competencia, 2008), excessive regulation has a negative effect on the efficiency of the sector--for example, there is evidence to suggest that Spanish professional services firms are on average smaller than in other European countries. (12) Co-ordinated actions between the transposition of the Directive and additional measures to liberalise professional services could exploit synergies that would boost the services sector and could have larger economy-wide effects on productivity and competitiveness. Therefore, the qualifications requirements for professional services should be reviewed and narrowed as much as possible.

[FIGURE 4.5 OMITTED]
Box 4.2. Recommendations to enhance product market competition
Strengthening the sectoral regulators

* Ensure that regulators have an arms-length relationship with
regulated firms, consumers and other private interests, as well as
with respect to political authorities. Restrict regulators to a
single term in office. Strengthen their regulatory powers and make
sure that their regulatory decisions are final and cannot be
overturned by other government offices. Make regulators accountable
to Parliament, with a duty to explain their decisions clearly and
transparently.

Energy markets

* Increase electricity interconnections with both France and
Portugal, as planned.

* Dismantle remaining entry barriers to generation activities,
streamlining the authorisation process for new infrastructures by
grouping all procedures into a "one-stop shop", formally setting
the co-ordination mechanisms among the interested entities, and
increasing the human and technical resources in charge of
processing the applications.

* Phase out regulated retail gas and electricity prices as soon as
possible, replaced by support to low-income households via
means-tested cash transfers. If regulated prices cannot be
eliminated for all consumers, then entrust the regulator to
determine them. In addition, the regulator should determine the
access tariffs to the distribution network.

* Reform the current system of capacity payments by providing a
variable payment that is linked to the use of capacity when
capacity utilisation is high, as planned.

Reducing greenhouse gas emissions

* Sell C[O.sub.2] emission permits through auctions as from 2012,
and support the elimination of the EU rules that allow the sale of
only up to 10% of the permits.

* Conduct more studies on the cost effectiveness of the feed-in
tariff regime for renewable sources of electricity generation,
comparing it with other abatement policies towards greenhouse gas
emission reductions.

Telecommunications

* Ensure that the combination of the incumbent's high prices and
elevated market share in the broadband market is not due to a lack
of competition in the wholesale access market.

* Allow the regulator, in an explicit manner, to mandate the
functional separation of the incumbent as a measure of last resort.

* Ensure that the incumbent is required to give sufficient notice
to alternative operators when it plans to shut down exchanges.
Update the current norms regarding common telecom infrastructures
inside shared premises to also cover fibre installations.

* Consider putting the operation of regional passenger transport
services out to tender on a compulsory and regular basis. Require
the incumbent to make its rolling stock available with
non-discriminating conditions.

* Remove the constraints involved in obtaining a road freight
haulage operating license, and reform the authorisation process to
make consolidation of firms easier. Ensure that road passenger
transport licenses are tendered on a competitive basis without
favouring incumbents.

Postal services

* Ensure an appropriate level of access of competitors to the
public postal network and ensure access to the address databases of
the postal services incumbent.

Savings banks (Cajas de Ahorro)

* Reform the regulation of the Cuotas Participativas for example by
removing the ceiling on individual investors' holdings. Explore
other ways for savings banks to increase their access to outside
equity.

* Remove the requirement for regional governments to approve
mergers of savings banks. Make approval by the Bank of Spain and
the competition authority sufficient.

* Lower the ceiling on public-sector representation in Caja's
General Assemblies.

Services

* Implement the European Directive on Services in an ambitious
manner, as planned by the government, in order to lower entry
barriers in services imposed at the regional level. Review and
narrow qualifications requirements for professional services, which
are not covered by the Directive.


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Notes

(1.) Both Endesa and Iberdrola function as operators of electricity distribution networks and as generators and as retail distributors.

(2.) When a firm increases its price, it faces the following trade-off: on the one hand, the higher price will decrease the quantity it sells, losing the revenue of some units at the margin. On the other hand, the higher price implies higher benefits from the energy that is sold. Having long-term and futures markets reduces the magnitude of the second effect, as price increases in the wholesale market do not affect the electricity sold through either of these mechanisms.

(3.) These distortions resulted from cost-based retail price regulation and from the fact that only vertically integrated firms could supply the regulated market.

(4.) The government plans to cover the target via the increase in emissions authorised by the Kyoto treaty (15 percentage points), the use of carbon sinks (2 percentage points), and by purchasing emission permits in international markets (the remaining 20 percentage points).

(5.) The 27 million tons of C[O.sub.2] represents the 13 percentage points increase beyond the 1990 level that is above the target of a 37% increase.

(6.) At that moment, the Spanish government assumed 70% of Renfe's total debt amounting to around 0.5% of GDP (5 459 billion [pounds sterling]), while an additional billion euros related to infrastructure was assumed by ADIF, in order to guarantee the solvency of the two new firms.

(7.) Mutual banks play only a small role, mainly in rural areas.

(8.) Some autonomous communities and some municipalities have launched targeted programmes that aim at offering young people attractive mortgage conditions. These agreements have to be assigned through competitive public tenders, equally accessible to all banking institutions. In some instances, in which the agreement was obtained by a local savings bank, the governments made available public buildings to promote these mortgages. This was the case, for example, of the region of Valencia, which set up an office to gather the applications and the required paperwork.

(9.) The autonomous communities decide the exact distribution of representation among the different groups.

(10.) In addition, the share of depositors in the General Assembly is limited by regulation to between 2B and 50%, and that of employees to between IS and 25%. Other entities are not subject to explicit limits.

(11.) Professions that are only regulated in Spain include, inter alia, marine engineer, air stewards, nautical engineers, mining engineers, nautical mechanics, administrative managers and oenologists.

(12.) For instance, Spanish engineering and architectural firms are under represented among Europe's biggest firms (see Swedish Federation of Consulting Engineers and Architects, 2006).
Table 4.1. Natural gas prices for industry and households US
dollars/toe, 20071

                 A. Prices for industry   B. Prices for households

New Zealand              231.9                    1381.3
Canada                   287.2                     542.6
Finland                  297.6                     426.2
United States            323.5                     555.0
Greece                   347.1                     667.6
OECD (2)                 356.7                     670.1
United Kingdom           369.8                     836.9
Mexico                   385.6                     701.6
Poland                   416.7                     765.0
Spain                    422.5                     964.3
Czech Republic           435.2                     641.7
France                   460.1                     873.1
Portugal                 476.4                    1194.4
Japan                    483.6                    1376.0
Turkey                   489.8                     577.2
Italy                    504.6                    1040.7
Ireland                  517.7                    1021.6
Korea                    612.3                     792.2
Switzerland              640.6                     963.1
Hungary                  649.1                     683.7

(1.) toe = tonne of oil equivalent. Data refers to 2005 for Greece
and 2006 for Ireland, Italy and Japan.

(2.) Weighted average.

Source: IEA, Energy Prices and Taxes, 2nd quarter 2008.

Table 4.2. Regulation indices for the liberal professions
in Spain and the EU15 (1)

                                   Lawyers           Notaries

                               Spain   Average   Spain   Average

Market entry
Total                           6.5      5.2      9.4      9.5
Entry regulation                3.4      2.8      4.6      4.8
Licensing                       6.0      4.0      6.0      5.6
Requirements in education       2.5      3.1      2.5      3.8
Duration of special             5.0      4.1      5.0      4.7
  education
Duration of compulsory          0.0      2.3      0.0      3.4
  practice
Number of professional exams    2.0      2.1      2.0      2.4
Number of entry routes          6.0      4.8      6.0      5.6
Quotas                          0.0      0.0      6.0      5.4
Market conduct
Market conduct regulation       3.1      2.3      4.8      4.7
Prices and fees                 2.0      1.7      6.0      5.0
Advertising                     4.0      3.2      6.0      4.6
Location                        0.0      1.2      6.0      3.4
Diversification                 3.0      2.0      0.0      5.1
Form of business                5.0      3.0      6.0      3.9
Inter-professional              6.0      3.7      6.0      4.9
  co-operation

                                  Accountants      Architects

                               Spain   Average   Spain   Average

Market entry
Total                           3.4      4.5      4.0      2.6
Entry regulation                1.9      3.1      3.2      1.6
Licensing                       1.5      4.0      6.0      2.5
Requirements in education       3.3      3.7      1.9      1.6
Duration of special             3.0      4.1      5.0      2.8
  education
Duration of compulsory          3.0      3.7      0.0      1.1
  practice
Number of professional exams    4.0      3.0      0.0      0.4
Number of entry routes          4.0      4.3      4.0      2.2
Quotas                          0.0      0.0      0.0      0.0
Market conduct
Market conduct regulation       1.5      1.4      0.8      1.0
Prices and fees                 1.0      1.2      2.0      1.8
Advertising                     4.0      2.4      2.0      1.9
Location                        0.0      0.0      0.0      0.0
Diversification                 0.0      0.9      0.0      0.0
Form of business                2.0      2.1      0.0      0.7
Inter-professional              3.0      2.3      0.0      1.2
  co-operation

                                   Engineers       Pharmacists

                               Spain   Average   Spain   Average

Market entry
Total                           3.2      2.4      7.5      6.6
Entry regulation                3.2      1.6      3.6      3.3
Licensing                       6.0      2.7      3.0      3.3
Requirements in education       2.1      1.4      2.1      2.5
Duration of special             5.0      2.4      5.0      4.8
  education
Duration of compulsory          0.0      0.8      0.0      0.6
  practice
Number of professional exams    0.0      0.2      0.0      1.3
Number of entry routes          6.0      3.0      6.0      5.3
Quotas                          0.0      0.0      6.0      4.4
Market conduct
Market conduct regulation       0.0      0.9      3.9      3.3
Prices and fees                 0.0      1.3      3.0      3.7
Advertising                     0.0      1.4      4.0      2.9
Location                        0.0      0.5      0.0      0.4
Diversification                 0.0      0.5      6.0      4.2
Form of business                0.0      0.6      6.0      3.9
Inter-professional              0.0      1.0      6.0      4.5
  co-operation

(1.) The higher the respective figure, the higher the degree
of regulation intensity (within a range from 0 to 12). me total
value for the index is a weighted average of the individual
components.

Source: Paterson, I., M. Fink, A. Ogus (2007), "Economic impact
of regulation in the field of liberal professions in different
Member States" European Network of Economic Policy Research
Institutes Working Paper No. 52, February.
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