Public policy towards cross subsidy

Abstract

Although elusive of measurement, cross subsidies are widely believed to have existed on a significant scale in network industries, particularly when these developed under public ownership. After providing careful definitions of when cross subsidy occurs, this article distinguishes eight distinct cases, drawing examples primarily from network sectors. Debates about the desirability of cross subsidy in the context of public enterprise are then reviewed; issues such as the geographical averaging of tariffs and the extent to which non‐commercial obligations should be reimbursed by government on the recoup principle are addressed. The policy package of denationalization, liberalization and new forms of regulation have far‐reaching implications for cross subsidy policy. For example, liberalization reduces the ability of incumbent enterprises to cross subsidize uneconomic links in a network, particularly if entrants are not subjected to comparable social obligations. Moreover, denationalized enterprises will more vigorously pursue financial profitability, discontinuing cross subsidy related to the traditional equity and political goals, but exploiting cross subsidy as an entry‐repelling tool. Both at the member state and European Union levels, there is evidence of confused thinking about the desirability and continued feasibility of cross subsidy; for example, not recognizing the inconsistency involved in imposing non‐economic obligations on incumbents while removing barriers to competitive entry. These developments not only erode the viability of the missions of public enterprises in their traditional sectors but also raise issues for public policy if and when technological developments make possible new forms of price discrimination in social sectors.