only Mercury would be licensed as a second public telecommunications operator so as to afford some protection for the smaller company and encourage it to invest more. Thus, promotion of competition was not interpreted to mean liberalization of the market based on a permissive licensing policy, but rather was seen as requiring the so called “duopoly policy” that was pursued in the 1980s.

It is partly because of this type of use of regulatory powers to promote competition that the new policies for the telecoms and energy industries in the UK can not be regarded as being a straightforward exercise in deregulation. Rather, the policies can best be described as major regulatory reforms which looked forward to the prospect of substantial deregulation of non-naturally monopolistic parts of the relevant industries in some future period when competition was firmly established.

### 6.3 Phase 3, 1987-92

Although it includes major asset sales such as British Steel and the British Airports Authority, the third phase of the privatization programme was dominated by the sales of the water (1989) and electricity (1990-91) industries and the accompanying regulatory reforms. The period also included the first reviews of the price-cap formulae in the telecoms and gas industries, and it saw a number of significant developments in the new regulatory regimes.

The water and electricity flotations were similar to the earlier telecoms and gas privatizations in that new bodies (Ofwat and Offer respectively) were established to regulate the industries and the flotations were heavily targeted at small investors. Unlike in telecoms and gas, however, in both cases there was substantial restructuring of the SOEs before privatization. In respect of water, restructuring was driven by the desire to separate environmental regulation from the businesses of water supply and the treatment and disposal of liquid wastes (these functions were bundled together in the public sector), rather than by any notion that competition might be increased as a result. Indeed, the Government explicitly recognised that the prospects for competition in the supply of basic services were poor, and instead emphasised the potential for the development of “competition by comparison” (another name for yardstick regulation) that existed by virtue of the fact that were many, regionally-based water utilities.

Pressures for improved water quality (for example, to meet European regulatory standards) meant that, at the time of privatization, the industry was planning for a large-scale investment programme, to be spread over a period of many years. This raised fears of possible underinvestment by privately-owned water utilities. Initial price controls therefore took the form of formulae which promised the utilities future prices that, year by year, would rise substantially faster than the general rate of inflation. The extent of the permitted annual increase in real prices varied from utility to utility, depending upon each firm's anticipated investment requirements. In effect, “regulatory contracts” were struck with the utilities allowing the latter to obtain finance for investment from consumers.

In contrast, in electricity industrial restructuring was driven by an attempt to increase