Foundations of Regulation

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[Response by Sophie Trémolet and Diane Binder, August 2009]

The main potential beneficiaries of infrastructure reforms are as follows:

Consumers – infrastructure reforms aim to protect consumers from private sector abuses and political interferences. In economic theory, benefit to consumers is generally measured as net consumer surplus, which is the difference between the gross value that the consumer receives when consuming the service (willingness to pay) and the amount the customer pays. Consumers’ welfare is maximized when consumers get the best combination of quality and price. However, abuses happen when service providers are in a monopoly position: the absence of substitutes encourages operators to overcharge or supply a service that does not meet quality requirements.

The establishment of a regulator can reduce problems of market power, by implementing tasks such as: setting overall tariff levels and structures to ensure that delivery of services is done at an affordable level while ensuring the long-term viability and efficiency of the operator; defining levels of service that meet customers’ needs and that can be provided at a financially sustainable and affordable costs; acting as a secondary complaint resolution mechanism, disseminating information and raising public awareness. Poor people specifically may benefit from reforms that encourage service expansion (particularly for those who were not previously connected) and from pro-poor policies¹, such as direct subsidies² or light touch regulation of alternative service providers.

Operators – reforms are usually implemented to protect the private sector from politically-driven decisions. Service providers, before investing, need that the government establishes clear and prospectively stable rules for setting prices, subsidies and tax policies. Regulation allows addressing this requirement, therefore encouraging investments and helping governments to achieve their objectives. Regulation also protects the operators from the risk of losing out when the government changes the rules of the game. This gives service providers the ability and incentives to make good investment decisions, by ensuring that they can get a reasonable return on assets if they perform well. Regulation ensures that operators compete on a leveled playing field, have a similar access to information and benefit from streamlined subsidies based on actual demand rather than on political arrangements. This can be particularly beneficial to new entrants (which also drives innovation) whilst it may affect incumbent operators negatively.

Governments – reforms allow governments to make informed decisions and increase their revenues. By reducing information asymmetry³, reforms allow the government to access private information held by operators about market demand and costs incurred for service delivery. The government can thus adjust its social objectives, tariff setting policies and regulation to the need of both operators and consumers. In addition, reforms generate revenues for governments from licenses and concessions.

The environment – By setting minimum quality standards and encouraging operators to choose optimal investments for environmental protection, infrastructure reforms may also benefit the environment.

Infrastructure reforms are more likely to translate into benefits if proper sequencing of reforms is followed and adequate institutional safeguards are in place, such as restructuring the industry before introducing privatization, and putting in place regulation first so that potential buyers can be assured and consumers protected. Successful reforms require careful planning.

Related Questions

• What are the foundations for regulatory activities in infrastructure?
  • Historic Rationale – What are the historical reasons leading to the creation of regulatory agencies around the world?
  • How can policy makers incorporate market failures in the design of infrastructure reforms?
  • Nature of the Benefits – Historically, what have been the main benefits of reforms?
  • Reformers – Who usually drives infrastructure reforms: governments, utility providers or sector regulators?
  • Beneficiaries – Who are the main beneficiaries of infrastructure reforms?
  • Opponents – Who may be hurt by infrastructure reforms and their unanticipated consequences?
  • Instability – How can regulators ensure stable (and predictable) regulatory regime under changing market and technological conditions?
  • Lack of political continuity – How can legislation be used as a tool for promoting stability and continuity in the reform and regulatory processes?
  • Risks – How can the regulator avoid unintended negative consequences when it adopts regulatory decisions?
  • Federal systems – What reform strategies and regulatory structures are best suited for large countries with federal system (multiple layers of regulation)?
  • Failed states – What reform strategies and regulatory structures are best suited in failed / post-conflict states?

Footnotes

1. Poor customers raise specific challenges for service provision and regulation: they are often served by a wide spectrum of operators, which are often informal; and they are more likely not to be connected to networks. Policies and regulatory frameworks can thus be designed and implemented in a way that is more conducive to expanding access and improving service to poor customers (Trémolet & Hunt, 2006). Back to Content
2. The efficiency of targeting subsidies onto the poor is however debated in question "Do higher income customers benefit more from subsidies than do poor customers?" Back to Content
3. Overview D and Chapter 3 on financial analysis focus on obtaining and using information. Back to Content