Business World, 22 July 2013


One never knows what will arise in conversations between economists and lawyers. A casual dinner with Popo Lotilla and other colleagues brought up topics far and wide: from the historical imprint left by Filipinos in Acapulco, Barcelona, and Bordeaux, to church art and prominent sacerdotal families in Betis, Pampanga. (The erudite Popo, of course, is the former energy secretary, ex-NEDA deputy director-general, and current PCED fellow-in-residence at the School of Economics.)

On a more utilitarian and topical note, however, Popo repeated his lawyerly observation that the idea of a “public utility” was not fixed in the law but a changing one. His favourite example is ice plants, which in the past were regarded as a public utility but are now no longer so. (Nostalgia among us then brought up the iconic Insular Ice Plant that used to be visible as one crossed Quezon Bridge.)

Popo’s astute idea is that the constitutional 60-40 nationality requirement on the ownership of public utilities (Art XII, Sec. 11) is not really cast in stone but rather fluid, since the definition of a public utility itself has been changing. Even without a constitutional change, therefore—which is not in the cards under this administration, anyway—significant parts of the economy could actually be opened to foreign investors if only specific legislation declared them to be non-public utilities. His more current example was the unbundling of the power sector, where he played a role. By identifying the natural-monopoly element in the value-chain (namely, transmission and distribution), the law made it possible for foreigners to own 100 per cent of generating plants (as well as the Chinese owning 40 per cent of Transco). So, Popo’s challenge to us economists was to come up with clear economic bases for denominating some industries as “public utilities”—in order that other sectors may be freed from such a designation and any unnecessary nationality restrictions consequently removed.

The problem, of course, is that there is no intrinsic definition of a “public utility” to go by. Even the law is ambiguous: while the Constitution speaks of “public utilities”, statutes since as early as 1939 (C.A. 454) have abandoned that term and refer only to “public services”, raising the question whether the two are even the same thing. Legal definitions of public utility are also vague. A well-cited definition proceeds only by examples, laying down no principles and only referring to “a business or service engaged in regularly supplying the public with some commodity or service of public consequence such as electricity, gas, water, transportation, telephone or telegraph service” [from American Jurisprudence]. The qualifying term “public consequence” is especially amorphous.

Here’s a stab at it: my own effort to seek a rational basis for the ownership restrictions in the constitution concludes that they probably reflect an implicit concern for national defense or security. This is quite legitimate and should cause no blushing among economists. Even Adam Smith asserted that “defense is of much more importance than opulence” when he defended Britain’s Navigation Acts, which effectively imposed nationality restrictions on shipping. Drafters of the constitution likely feared foreign control of important sectors which—if relations with foreign nations deteriorated—could be weaponized and used to undermine the home-country’s defenses. Think of illicit intelligence-gathering and misinformation through the telecoms systems, or sabotage or withholding of service in power, water, and transport. (I leave open the question whether fellow-Filipinos cannot be worse enemies of their own country in peace than foreigners during a war.) If this premise is true, then a minimal criterion for a public utility designation should be the activity’s potential importance in civil defense and national security.

From this broad security or defense concern flow two other criteria for a possible characterisation. First, public utilities should typically affect or be patronised by broad sections of the population. After all, crippling a transport or communications system on which multitudes depend would certainly be of “strategic” importance (in the original Greek sense).  By contrast, a disruption of the supply of phablets would probably not do much damage. From this also flows the principle that industries devoted mainly to serving mainly foreign demand (i.e., exports) cannot be called public utilities. Hence, for example, there is no reason foreign-owned cruise ships carrying tourists should not be allowed to navigate inland waters freely and put into domestic ports, or even put up and operate their own wholly-owned ports in the process. Foreign-owned and operated international airports might also be considered under this rubric. The same principle also means that toll ways and freeways cannot be properly regarded as public utilities, since their function inherently demands that public access be restricted to avoid congestion (with the toll serving as the rationing device). The more exclusive the access to an activity, the more it resembles a club good or service; the less it qualifies as a public utility.

The club-good exception is in fact already well established in the law (with a 1923 precedent involving, of all things, an ice plant!): if a facility provides services under private contract then it is not a public utility. On this principle, then, there should even now be nothing to prevent, say, a completely foreign-owned and -operated transport system (or telecommunications, or power distribution system) from serving any number of subdivisions or industrial estates under private contract. The bottom line is that “public utility” cannot refer to activities that do not serve or affect a wide general public.

A second criterion to consider is whether the good or service provided entails a natural monopoly. This does tend to be the case for many network industries—think of telecommunications, power transmission and distribution, railways, and water distribution—where the required infrastructure is idiosyncratic, sunk costs are large so that both entry and exit are difficult, and average costs fall with a larger subscriber base. Even abstracting from nationality of ownership, such a situation already presents a case for some form of regulation for the consumers’ sake. In addition, however, the strategic consideration is obvious. If malice existed, a smaller number of foreign providers could make it easier for outside parties to threaten security. In the light of our current territorial disputes, for example, one might imagine the degree of state insecurity if, say, the Philipines’ Transco were fully owned by State Grid of China (which already currently owns 40 per cent—whoops!). By contrast, while the supply of rice is of undoubted national importance, no one would seriously suggest its processing and distribution should be designated a “public utility”. This is in large part because it is in the hands of many agents, diminishing the likelihood of malicious combination. Notwithstanding the paranoia against the Sangleys by earlier generations, the existence of many suppliers would have been a sound reason to argue that the Retail Trade Nationalization Law was a bad idea all along.

More sophisticated regulation has also provided greater flexibility in this respect. “Unbundling”—the legally ordained separation into separate enterprises of various stages of a hitherto vertically integrated operation—typically isolates the parts of the process subject to natural monopoly, allowing competition and free entry in other parts. In the power sector, for example, distribution and transmission have remained monopolies, but generation and retail have not. In this instance, the law has effectively determined that the “public utility” label—and therefore the relevant ownership restriction—is substantively applicable to transmission and distribution but not to retail and generation. The reason is implicitly found in the contestability of the latter two stages; hence direct foreign ownership is feasible. This template is also applicable, say, to telecommunications and water-supply systems. While “tubes-and-pipes” systems might be subject to public-utility ownership rules, what flows through them need not be. Such a delineation can be used, for example, to lay the ground for the development and operation of dams, water-impounding, and other water-supply projects by foreign direct investors, while various value-added services and content can be provided by foreign entities using the broadband, cellular, broadcast, or other transmission services of current telecoms incumbents. (Regulatory mechanisms may be needed, of course, in order to enforce access to such networks, but those are called for in any case.)

To sum up, one might consider the following lean characterisation of a public utility: it refers to a service or activity characterised simultaneously by (a) broad public access or dependence (inelasticity of demand); (b) inherent seller-concentration (noncontestability), and (c) nontrivial implications for civil defense or national security. Nationality restrictions might in principle be justified in such cases. But they should be seriously reconsidered in all others.

Proceeding in this way does not seem to be significantly more tedious than the proposal to go the route of constitutional change. For all the hue and cry, all the current proponents of charter change want to accomplish is to insert the phrase “unless otherwise provided by law” in the relevant constitutional provisions—a change that per se will not directly stimulate foreign investments anyway. Even with charter amendment, legislators must in the future still do the grunt work of examining each industry in detail and enacting specific legislation for it. We suggest here, however, that they can begin with that difficult task even today by simply applying a leaner definition of a public utility. The real work can start now.

Rather than dream of some magic bullet, therefore, society and its leaders should ultimately realise they cannot avoid messily and prudently transacting that balance and mutual dependence between opulence and defense, which even Adam Smith recognised.