Silviase/jgov_v1.4_full_ann huggingface dataset:
common to public utilities overall and the agricultural/distribution sectors.

Comprehensive reviews on regulation are called for from this aspect. The subsequent section deals with rating and supply/demand problems in details to confirm their real state.

### 2.2 Rate-making Issues

#### 2.2.1 Rate Levels

## (1) Differentials between domestic and overseas rates

Japan’s electricity is certainly more expensive than in major countries if compared by using exchange rates. Looking at 1993 figures with Japan taken as 100, the US was 77, Britain 65, France 59, and Germany 73 (Figure 13).

The big differentials between domestic and overseas electricity rates are attributed to the sharply appreciated yen on the exchange rate. Indeed, if compared on local currency basis how much electricity rates were increased in 1980-93, it is found that Western countries raised rates by around 30-80%, while Japan cut its rates by about 13%. Also, if compared with price increase rates of general goods (ex. comparisons with CPI or WPI), electricity tariffs are falling in relative terms.

A study (1995. 1. 26) of the Rate-Making Subcommittee of the Electric Utility Industry Council points out six reasons why Japan's electricity rates are higher. They are: 1) appreciated depreciation costs of the past equipment investment due to the rising yen; 2) rising equipment costs due to high demand growth; 3) falling annual load factor (utilization factor of capacity) due to spiraling summertime peaks; 4) inflated wages by the strong yen; 5) environmental investment and high fuel cost needed to achieve stringent environmental standards; and 6) land-related constraints.

However, these cannot justify differentials at home and abroad to be left intact. The differentials are causing serious problems to export industries. General consumers on their part still strongly feel that electricity is more expensive (Figure 14).

In fact, the problem of domestic and overseas electricity price differentials stems from the fact that efficiency improvement by the electric utility industry fails to catch up with the pace of yen's appreciation. Export industries manage to retain their price competitiveness even hit by the strong yen, because they have adjusted their own productivity and production factor prices to the pace of the yen's appreciation. From this standpoint, it is often argued that the problem of domestic and overseas differentials is a problem of gaps in productivity among domestic industries.

Actually, even if the environment of the Japanese electric utility industry may be different from that of its overseas counterparts, the industry is surely behind major manufacturing industries at home in such terms as capital cost and rate of productivity improvement.
## (2) Electric utilities and in-house power generation/cogeneration

There is a problem that electricity sold by electric utilities is more expensive than that produced from in-house power generation and cogeneration. Indeed, an increasing number of in-house power plants can be attributed to the better economics of in-house power generation.

For instance, the strong yen made overseas coal and oil available for less than ever. Those who practice in-house power generation can take advantage of the strong yen in the form of falling fuel prices. As a matter of course, given differences between in-house power producers and electric utilities in sitting, costs incurring in environmental/security control, and technical elements of transmission grids, a simple cost comparison is prohibited.

However, electricity rates at the end-user level are becoming more expensive than in-house power generation due to the strong yen. This is also true of cogeneration. $ ^{[14]} $

#### 2.2.2 Rigidity of Rating

## (1) Regulation of fair returns

There are many discontents and arguments of the electricity rating system itself. With the existing rating system, electricity rates are set by adding fair returns to the supply costs. Some criticize that the regulation of fair returns can induce inefficient production in theoretical terms. It is the so-called Averch-Johnson effect (1962).

Corroborative studies on the Japanese electric utility industry have not produced a solid conclusion in regard to the A-J effect. However, at least it is certain that the present rating system does not contain any incentives to enhance production efficiency.

## (2) Market efficiency

The shortcomings of the present rating system from the standpoint of market efficiency cannot be overlooked.

Electricity consumers are manifold, ranging from residential/commercial to industrial. Rating levels applicable to individual consumers are then distributed according to consumers' characteristics by expense item. It is the called fully distributed cost (FDC) method. At a glance, this method looks fair. But from such standpoints as production factor and optimal distribution of resources, it is not necessarily fair.

Theoretically the second best rate-making system from a market efficiency aspect for the case where the cost plus returns are guaranteed, namely, after the restraint is imposed to secure a balance, is the so-called “Ramsey pricing.” The greater dissociation of actual rate levels from the Ramsey price implies greater damage given to social welfare. A collaborative study by Matsukawa et al (1993) suggests such a possibility.

On top of the employment of FDC method, all the rates set by consumer group are subject to approval of the regulatory authorities. This makes elastic rating harder for electric utilities.
## (3) Growing regulatory cost

Thus, a rate-making system based on fair returns regulation and FDC, combined with meticulous approval procedures taken by regulatory authorities, has proved very much time-and labor-consuming for both the electric utilities and regulatory authorities alike. Indeed, an asymmetry of information can emerge between electric utilities and regulatory authorities. In order to balance this asymmetry, examinations by the regulatory authorities can become even more time-consuming.

Every time rates are revised, electric utilities must allocate hundreds of their employees to relevant works for a few months. The regulatory authorities, for their part, work hard for checking, and often work without sleep or rest. Naturally, details of expenses are never disclosed to the public at large.

Consequently growing regulatory costs, as well as their complexity and opaqueness, precipitates discontents of existing rating system.

## (4) Rising ratio of capital costs

From the cost of rates of the electric utility industry, rising capital and repair costs can easily be noted. As already pointed out, it stems from 1) prolonged lead time of power plant construction, 2) plants located increasingly in remote sites, 3) resultant needs for giant transmission networks, and 4) deteriorating utilization factor due to falling load factor, among other things.

Under present conditions, the fuel cost favorably affected by the strong yen holds a mere 13% of the cost. The greater share held by capital-intensive and less fuel-cost-intensive power sources, like nuclear, means an ever-rising ratio of capital costs. While raising capital overseas is becoming gradually popular, an overwhelming portion of funds has been raised at home so far.

In such a situation, while the environment urges the economy to link itself with its overseas counterparts, electricity rates alone head further toward cementing rigidity.

### 2.3 Supply and Demand Problems

#### 2.3.1 Problems on Demand Side

## (1) Growing residential/commercial demand

Growing residential/commercial demand means sharp load fluctuations on not only daily but annual basis. Above all, growing air-conditioning use of residential/commercial demand in recent years poses a crucial problem to form peak load in summer and winter. As a result, a recent trend is that system peak load (kW) grows higher than electricity demand (kWh). This is because summertime air-conditioning load for commercial/residential uses is expanding. Taking annual average growth rates in FY 1986-92 as an example, system peak load grew 6.6%, compared with a 4.6% rise in electricity amount sold by electric
utilities.

## (2) Worsening load factor

Due to these tendencies, the average load factor (net: average power load/peak 3-day average) among nine utilities has deteriorated year by year to 56% in FY 1992. However, due to a combination of recession and a cold summer, the system peak load was not renewed in FY 1993 and the load factor stood at 59.2. Thus, rising residential/commercial demand and resultant worsening load factor have formed rate-increase pressures.

As demand control measures to level the load, (a) rating system-based incentives, (b) development/introduction of heat accumulators, etc. have been in put in practice. In regard to industrial consumers, thanks to the introduction of different rates by time zone, interruptable contracts, supply/demand adjustable contracts, and other factors, rate-making systems designed for load adjustment have functioned effectively recently. A time-of-use rating system was also introduced in January 1988 for large industrial customers.

But, residential/commercial customers are not yet sufficiently provided for. For instance, the time-of-use rating system applicable to residential customers, tentatively introduced in November 1990 and evolving into full-scale introduction in June 1992, won a mere 100,000 contracts or so, or 0.2%-short of overall customers.

#### 2.3.2 Problems on Supply Side

## (1) Power resources development

The most serious problem on the supply side is the difficulties in power resources development which stem from PA(Public Acceptance) issue. For this reason, the lead time from planning to commissioning a newly-built power plant is prolonged. This is true not only of nuclear but of coal thermal power as well.

Moreover, new sites are located increasingly in areas remote from consuming areas; this requires installation of long-distance transmission networks.

## (2) Safety regulations

Existing safety regulations too remain unchanged from those set in 1964, without reflecting 1) technical advances to date, 2) improved safety records, 3) the advent of decentralized power sources, and 4) changing consumer needs. The sense that existing regulations are outdated can never be wiped out (Figure 15). It is reported that the charges paid by Japan's electric utilities to heavy electric machinery makers are nearly double that is paid by their overseas counterparts. The higher charges result from excessive safety regulations, which in turn push electricity costs up.
### 3. Evaluation of Conventional Regulations

Based on present regulatory conditions and performance of the electric utility industry as discussed so far, existing regulations need to be evaluated first.

At the least, the postwar system of the electric utility industry can highly be evaluated regarding following points. First, electric utilities have constantly supplied highly reliable, top-quality electricity. Second, they have achieved high efficiency in technical terms as demonstrated by generating efficiency. Third, they have provided models of pollution abatement.

On the other hand, however, some claim that existing regulations impede efficient electricity supply. Some of the emerging problems from the electric utility industry have already been pointed out. Therefore, this section picks out only the essential problems of regulating the electric utility industry. They are regulations of entry and rate-making, and evaluation of yardstick competition under regional monopoly.

### 3.1 Economy of Scale

General electric utilities are allowed to be regional monopolistic operators because their business operation is regarded as a natural monopoly. To organize the inherent monopolistic nature, subadditivity of cost is a necessary condition. “Economy of scale” which traditionally has provided the grounds for natural monopoly is included in subadditivity, and is a sufficient condition to justify inherent monopoly. Hence, the grounds for whether it is necessary or not to allow a regional monopoly for general electric utilities are verified from the standpoint of economy of scale.

#### 3.1.1 Reviews on Past Studies

There are numbers of studies designed to verify if economy of scale exists in the case of Japanese general electric utilities (Table 2).

Their essence is outlined below. First, limiting to the generating sector, Izawa (1983) judged from data on the 1979-81 period that economy of scale existed. However, Awata et al (1987) denied its existence based on 1969-84 data. Furthermore, based on their calculation of 1966-84 data, Nakanishi/Ito (1988) argued that economy of scale was there but turned to nil later within the period of data studied. Then, Shinjo/Kitasaka (1989) in their study on 1975-85 data, concluded that there was economy of scale on the average, which, however, disappeared in the case of large-size firms.

Also, calculations were made on overall corporate management, covering transmission, distribution, and administrative sectors, in addition to the generating sector, the results are as follows. Nakanishi/Ito in their study judged there was economy of scale even at the level of overall corporate management. Conversely, Shinjo/Kitasaka doubted its existence and concluded in their study that a limited number of high-ranking firms could enjoy economy of scale.
scale, but others of middle-standing or lower could be dominated by poor economy of scale.

Given a summary of these demonstration studies, it appears that there is no choice but to question the presence of economy of scale in the electric utility industry at both levels of generating sector and overall corporate management.

As done in these studies, an attempt is made below to verify economy of scale in the industry by using the latest (1976-93) data.

#### 3.1.2 Model

Following former examples, the model in use employs production function of trans-log type; its twin, cost function, is used in actual estimation. Putting generated output as Q, and, of input production elements, labor as L, fuel as F, and capital as K, production function can be expressed as follows.

$$ \mathrm{Q}=\mathrm{f}(\mathrm{L},\mathrm{F},\mathrm{K}) $$

Assuming that an electric utility, under rating regulation, behaves to minimize total cost while satisfying electricity demand (Q), which is exogenously determined, total cost (LTC) can be expressed as follows.

$$ \mathbf{L T C}\left(\mathbf{t o t a l}\;c o s t\right)=\mathbf{g}(\mathbf{P L},\;\mathbf{P F},\;\mathbf{P K},\;\mathbf{Q}) $$

PL: Wage rate

PF: Fuel price

PK: Capital service price

At this point, SCE, a yardstick to measure economy of scale, is expressed as follows.

$$ SCE=1-\left\{\partial\ln LTC\mid\partial\ln Q\right\} $$

Where SCE > 0, there is economy of scale.

Meanwhile, total cost function of trans-log type is expressed as follows.

$$ \begin{aligned}\ln LTC=&\alpha_{0}+\alpha_{q}\ln Q\\&+1/2\beta_{qq}(\ln Q)^{2}\\&+\sum\quad\alpha_{i}\ln P_{i}\\&+1/2\sum\sum\beta_{ij}\ln P_{i}\ln P_{j}\\&+\sum\quad\beta_{qi}\ln Q\ln P_{i}\end{aligned} $$

In order to satisfy conditions of symmetry of two-story partial differential, and of homogeneity of price, the following restraints are imposed on individual parameters.

$$ \beta_{ij}=\beta_{ji} $$

$$ \sum_{i}\alpha_{_{i}}=1 $$

$$ \sum_{i}\beta_{ji}=\sum_{j}\beta_{ij}=\sum_{i}\quad\sum_{j}\beta_{ij}=0 $$

$$ \sum\beta_{\mathrm{q i}}=0 $$
$$ \mathrm{SCE}=1-(\alpha_{\mathrm{q}}+\beta_{\mathrm{qq}}\ln\mathrm{Q}+\sum_{i}\beta_{\mathrm{qi}}\ln\mathrm{P}_{\mathrm{i}}) $$

#### 3.1.3 Estimation Results

Outlined below are results of the estimation made by using the aforementioned model.

As for thermal power generation, with some exceptions for Hokkaido, Hokuriku and Shikoku, the SCE of other companies are positive, and means that economy of scale exists (Table 3). And Looking at the coefficient by years, recent figures are becoming larger than those of the past. This might be caused by the stagnant fuel prices after the mid 1980s.

However, as for nuclear power generation, most of companies' SCE are negative, without Kansai and Kyushu. Therefore, at least economy of scale in nuclear power generation is very uncertain.

In terms of overall corporate management which covers transmission, distribution and administrative sector on top of generation, the SCE of most of companies are slightly positive, with the exception of Hokkaido, Tohoku and some years of Kyushu (Table 4). Looking at the figures by time series, value is improving a little. This is also probably related to fuel prices.

In summary, we estimate that economy of scale in the electric utility industry exists in some form, with the partial exception of the nuclear power generation sector and some companies.

### 3.2 Rating Levels and Market Efficiency

While the existing rating system employs a customer-by-customer FDC method, it is feared that the method damages economic welfare. For a firm offering a number of services, like an electric utility, there is the Ramsey price as a pricing system designed to maximize economic welfare under the condition of balance restraint.

Matsukawa et al (1993) in their study divided electricity demand into residential and industrial uses, and calculated the Ramsey price by estimating price elasticity and marginal cost of electric utilities. Comparing the estimated Ramsey price and the present rating levels, they concluded that unit price for residential customers should be higher than that at present, while that for industrial customers can be much cheaper (Table 5).

### 3.3 Yardstick Competition

Have general electric utilities, for which regional monopoly is allowed, endeavored to improve their corporate management through inter-industry competition by comparing their performance with that of other utilities? This is a question which involves the issue of yardstick competition among electric utilities. The conventional regulatory system contains no mandatory rule to deny the concept. Therefore, the question raised above is not a
question designed to evaluate regulatory results of the past, but rather a question directed to electric utilities, which asks them if they have made such voluntary efforts. But, if it is confirmed that yardstick competition does function, even on a voluntary basis, it would mean for regulatory authorities that they are allowed to conduct market research as a step to introduce new regulatory instruments.

As a collaborative study on the yardstick competition in the Japanese electric utility industry, the study by Ito/Miyasone (1994) is viable. According to them, the fact that differentials among the nine utilities have gradually narrowed in cost terms (up to 1985) can be taken as an outcome of competition.

Technical improvement and quality competition have functioned more effectively. Individual utilities have uniformly attained high levels of technological introduction, which led to unmanned power plants, improved thermal efficiency, sharply lowered transmission losses, and thunder-proof/saline-proof distribution facilities. Also, a very limited outage, measured in both number and duration of blackouts --as well as stability of voltage-- proves that Japan's utilities have reached the world's top level in quality of electricity. As far as corporate management efficiency is concerned, however, it is not certain if competition has worked or not.

These results can be thought of as the highly successful outcome of the efforts made by individual utilities, by comparing their own data with those of others in various fields.

However, it can also be argued that the successful outcome is due to the regional monopolistic system, which enabled individual utilities to invest in technology and quality without paying enough attention to cost/benefit. It is sometimes pointed out that quality of Japan's electricity is higher than necessary. Likewise, as indicated by many experts (Vickers, J. and G. Yarrow (1988), an outcome of “possible conspiracy” can also be read from the narrowing differentials of rates, regardless of whether the parties concerned were conscious of it.

At any rate, it is a solid fact that the yardstick competition among nine utilities has functioned very well in the phase of technology and electricity quality, and that it has worked in narrowing regional differentials in the phase of rate. Nonetheless, verification has remained insufficient in regard to management efficiency.

From the standpoints above, of conventional regulatory outcome can be summarized as follows. First, the conventional system helped realize a stable electricity supply, and also contributed to the development of Japan. Second, economy of scale in the generating sector has reached its limits, and it is uncertain if economy of scale can be expected for overall corporate management. Third, the current rate system hinders market efficiency and fourth, while general electric utilities are allowed a regional monopoly and given service areas of their own, yardstick competition has functioned reasonably.
### 4. Deregulation Under Consideration

The contents of deregulation of the electric utility industry, currently under consideration along with amendment of the Electric Utility Industry Law, can be grouped in four categories(Figure 16). They are 1) liberalization of the entry into the electricity wholesale market, 2) activation of direct supply 3) change of rating system, and 4) revision of safety regulations.

### 4.1 Liberalization of Entry into Electricity Wholesale Market

## (1) Opening of electricity wholesale market

So far, those who hope to participate in the market as an electricity wholesaler need to obtain a “license” issued by the MITI Minister. The deregulation under examination calls for removing the licensing system and leaving the matter to the market. It is a “bidding system” that replaces conventional “licensing.” An interim report released December 1994 by a subcommittee to discuss the industry’s basic problems, under the Supply and Demand Committee of the Electric Utility Industry Council, mapped out specific procedures to work out a proposed bidding system as follows.

1) Size of supply capacity subject to bidding is to be specified when power resources development plans are prepared by general electric utilities.

2) General electric utilities will prepare and publish bidding plans, which state the size subject to bidding, time to start supply, bidding conditions (avoidable cost, etc.), evaluation method, and standard agreement, and other considerations.

3) Application by bidders

4) Decision of successful bidders

5) Contract based on standard agreement

The aim of introducing this kind of bidding system is to encourage in-house power producers and cogeneration operators to participate in the electricity wholesale market. It is expected that the power resources entitled to bidding will be those which can be developed within seven years.

However, nuclear-power generation, which requires a long development period and involves great uncertainties in the future, and such large-size power resources as LNG, are not counted in that category. They remain as the power resources to be developed by general electric utilities and wholesale electric utilities power producers, with “licensing” is kept alive, as in the past. Also, the licensing system for conventional wholesale electric utilities survives intact.

## (2) Free access to transmission networks

Even if barriers to new players in the electricity wholesale market are reduced by the introduction of a bidding system, the market will not necessarily be competitive. To prevent