Foundations of Regulation

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

Utility regulators are confronted with two seemingly conflicting challenges. On the one hand, regulators are responsible for providing a stable and predictable regulatory environment, in which investors, operators, and customers can make long-term decisions with confidence that short-term political goals will not affect the efficiency of utility services. On the other hand, the regulator must adapt the regulatory system to economic, social, and technological realities that are changing rapidly in directions that are at present unknown. This uncertainty makes it hard for regulators to plan and put at risk benefits that stakeholders have come to expect from the regulatory process. Instability in infrastructure markets relates both to events that are external to the sector, such as an increase in fuel prices on global markets or the devaluation of the local currency, and to events internal to the sector, such as technological breakthroughs. The former brings about unexpected costs that can weight heavily on operations and raise the issue of cost pass-through, while the latter can create competitive pressures, the need for a new market structure and potential changes to the regulatory framework.

Regulation thus needs to adapt to emerging problems, changing circumstances, and new information and experiences in regulated sectors. Proactive regulation can also foster the development and application of new technologies in ways that will better serve network development and other policy objectives. Regulatory flexibility is especially imperative in sectors experiencing rapid technological and market changes such as the telecommunications sector.

Policy makers and regulators must reassess the extent to which, in the new environment, the existing regulatory framework:

• Creates artificial barriers or unjustified biases that favor one segment of the industry over another and prevent technological innovation from being adopted;
• Adequately addresses new public service and public interest opportunities and requirements;
• Facilitates the application of the new technological and service possibilities toward extending network and service development to unserved and underserved regions and persons¹.

The institutional set-up of regulation is also instrumental to adapting to changes in the overall environment. Regulation by agency seems preferable to regulation by contract, as the latter pre-specifies regulatory treatment (such as indexing, automatic pass-through or case-by-case determination) for the individual cost elements that together determine the retail price, and as such, is less flexible to adapt to external changes. Besides, when facing a major disruption in the market, a regulatory framework needs to address several issues simultaneously, such as interconnection, universal access, means of dispute resolution, market definition methodologies, licensing/authorization procedures, and tariff-setting principles. In the case of regulation by agency, the body of regulations can then be amended in the light of market and technological developments. This would be more difficult in the case of a regulation by contract, where inflexibilities built into privatization agreements are often a severe impediment to solving post-privatization regulatory problems.

The telecommunication sector is an interesting example of this. Telecom reform has been primarily associated with or in response to the technological changes of the first wave of technological development (digital technologies, such as computerization). The key features of the second and third waves (respectively Internet technologies and ubiquitous networks, e-commerce and the like) challenge the established regulatory paradigm in a number of ways: many new technologies are expected to be on a smaller scale and less expensive to deploy. This changes investment cycles and patterns, speeds up the introduction of new products and services, and enhances possibilities for competition. Smaller players will be able to enter markets and fuel network expansion with relatively small-scale investments, provided that the policies and regulations are not obstructive. Compared to the relatively simple success criteria of fostering network development through competition and universal access rules that characterized the first wave, regulators need to establish multidimensional success criteria. For example, traditional price regulation must be reexamined not only regarding the implications of new mobile technologies, such as 3G, but also regarding the combined effects of mobility with the Internet, New Generations Networks (NGNs), and other dimensions of convergence.

In the case of the telecom sector, the evolving regulatory frameworks have facilitated and even encouraged the introduction of new technologies and services. They took into account that new technologies would disrupt (or make obsolete) pre-existing business plans and thereby the value of assets. However, such proactive regulation has for now been limited to the telecoms sector, and other utilities sectors should inspire from it in the view of adapting their own regulation to changing market and technological conditions.

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. New wireless services, including WiMAX, Wi-Fi, and 3G, offer new opportunities for improving universal access. However, these new technologies are also challenging current schemes for funding universal access by industry cross-subsidies. In many countries, those schemes are still focused entirely on fixed network service provision by incumbent operators. New technologies, competition, and the shift of voice traffic away from the traditional fixed network public service are all signaling that this traditional mechanism for funding universal access network development has become obsolete, unfair, and ineffective. Policy makers need to develop alternative approaches relevant to the new environment (Telecommunication toolkit). Back to Content