Foundations of Regulation

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

Failed and post-conflict states are environment where few, if any, government or legal institutions operate at all. In these countries, the supply of utility services can and does take place on a limited scale largely through local entrepreneurs, using voluntary arrangements and private mechanisms (such as private militia) to enforce decisions and payments. Government entities are not involved in these arrangements, because they do not exist or do not function.

For example, in Somalia (Schwartz, Hahn and al., 2004), which is often described as the "quintessential failed state", telecom services are functioning to a remarkably widespread degree. However, the absence of a regulatory framework means that there is no standardization of number frequencies and that interconnection between operators remain limited. Urban electricity is available to a lesser extent at reasonable prices compared to neighboring countries. A number of cities have local monopoly suppliers who use second-hand generators and supply electricity over local distribution networks. The private contracts observed represent a form of "quasi-regulation". This arrangement may or may not lead to a more formal regulatory system. There are limits to the type of investments and industry structures that can be supported by these quasi-regulatory arrangements.

The particularity of post-conflict states for utility service provision is related to the absence of a stable and secure environment (DDR policies, including disarmament, demobilization, and reintegration are often underway), the existence of camps for displaced people and massive migration movements. As political stability and regulation are crucial for investment, conflict-affected countries are even more likely to have associated high-risks premiums and are not necessarily sound enough for IFI or donor guarantee support.

In defining the actions required to support better functioning and more efficient infrastructure service delivery in failed states, it is necessary to differentiate between emergency assistance and longer-term development policies. The actions described below pertain to the later.

Reform strategies:

• Encourage small-scale informal utility providers to get services up and running, with the expectation that private investments would grow with increased stability.
• Gradually introduce private sector participation, for example with management contracts before progressing to leases and concessions. The use of political risk insurance instruments, such as those provided by MIGA and others, could potentially help with mitigating political risks in such circumstances.
• Implement mechanisms where investments can be supported by contracts with large industrial customers. This is particularly applicable to electricity services and can provide a good starting point for rolling out distribution in neighboring areas.
• Improve coordination between supply companies in order to extend the markets served.
• Establish dispute resolution procedures that go beyond the current informal clan.

Types of regulation to be implemented:

• Do not set harsh conditions when setting up regulatory mechanisms. The potential risks associated with a stringent regulatory system would be to restrict new entrants’ activities and force them out of business. To avoid this, Schwartz, Hahn and Bannon (2004) call for a "minimum level of oversight to alleviate extreme cases of rent-seeking and quality service deficiencies". To this view, a greater ability to write, monitor and enforce commercial contracts needs to be developed, possibly through technical assistance from international donors.
• Regulation by contract can be used in the first place, and considered as a transitional stage for evolving towards regulation by an independent regulatory agency. The ability to do so would depend on the existence of a local legal tradition that gives comfort to investors that contracts will actually be enforced. Countries that are not yet in a position where the legal arrangements allow regulation by contract administered by the courts or a contract-monitoring body. For countries in this position, the available regulatory options are more limited and more constrained. One possibility is to provide contract enforcement by an agency outside the country, for example, an international arbitration body or an international group of experts, but this leaves major problems of enforcement within the country, which can be highly contentious politically. Otherwise, the options are likely to include quasi-regulatory arrangements similar to those described in Somalia.

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?