Transcript Economic Reforms and Regulation of Infrastructure

Reform and Regulation of
Infrastructure
By
Shantha Jayasinghe
(Research Officer- Institute of Policy Studies)
Issues in Infrastructure
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Importance of Infrastructure networks
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Lack has effects on:
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Share of National Product and influence economic growth
Competitiveness of the economy
Living conditions of the people
High ratio of sunk cost that deter entry
Government Provision
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Reasons:
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Government usually does not go bankrupt
Public Goods
In Sri Lanka: poor quality and coverage
Infrastructure in Sri Lanka
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Electricity: Access- 74% of households
Relatively high cost of electricity in Asia
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Increased reliance on expensive energy
Telephone: Land or Cellular – 24%
Firewood for cooking – 83%
Well or Pipe-borne water - 62%
(Source: Development policy review, WB and CBSL)
Comparison of Electricity Tariffs of ASEAN
Countries (source: World Bank)
Sri Lanka
Residential
- low
Malaysia
Residential
- high
Singapore
Commercial
- low
Thailand
Philippines
Commercial
- high
Indonesia
Industrial
- low
Laos
Industrial
- high
Government Failure
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Principal – Agent Problem
“how to get the employee or contractor
(Agent) to act in the best interests of
the employer (principal) when the
employee or contractor has an
informational advantage over the
principal and has interest different from
those of principal”
Government
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Principal – Agent Problem
People
People’s
Representatives
Board of
Directors
People’s
Representatives
Board of
Directors
Employees
Private Sector
Principal- Agent Problem
Shareholders
Board of
Directors
Board of Directors
Employees
Why are Markets better?
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Decentralized decision making
Maximize the benefits of resource
allocation
Provide incentive for innovation
Markets relatively better than
centralized decision making
Infrastructure Reforms
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Key characteristics:
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Subject to elements of Natural Monopoly
“Natural Monopoly” Vs. “potentially
Competitive” segments in the market
Natural Monopoly
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“Natural Monopoly exists in a particular
market if a single firm can serve that
market at lower cost than any
combination of two or more firms”
Natural Monopoly exists because
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Economics of Scale: Producing more units
results in lower unit cost.
Economics of Scope: Producing multiple
products together results in lower cost
Design of Market Structure
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Separating out the natural monopoly
Electricity
Gen 1
Gen 2
Gen 3
Transmission
Dist 1
Dist 2
Dist 3
Creating Competition
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Competition in the Market :
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If it is cheaper and technically feasible to
have more than one provider:
Ex-post (After the event) regulation:
Independent Competition Authority
regulate anti- competitive behaviour
Creating Competition
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Competition for the Market :
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Auction to force the potential monopolists
to compete with each other for the right to
be the single supplier of a network:
Regulation is necessary
Ex-ante (Before the event) regulation:
Sectoral Regulation by Independent Body
Creating Competition
Sector
Noncompetitive
Component
Competitive
Activity
Electricity
Transmission & local
distribution
Generation & supply
Telecom
Residential telephony
Long distance, mobile,
value added services
Water
Water main and waste
water
Collection & treatment
Air Services
Airport Facilities
Aircraft operation,
maintenace facilities
Railways
Track and signalling
Train operation,
maintenance
What is Regulation (Ex-ante)?
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Broadly defined as imposition of rules
by government, backed by the use of
penalties that are intended specifically
to modify the economic behaviour of
individuals
and
firms
towards
maximizing welfare
Why do we need to regulate?
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Market Power
Imperfect information
Externalities
Joint Provision and consumption
Externalities
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A situation where the effect of
production or consumption of goods
and services imposes costs or benefits
on others which are not reflected in the
prices charged for the goods and
services being provided.
Eg: Pollution
Regulatory Strategies
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Command and control
Where legal authority and the command of
law is used to pursue policy objective
 Strength:
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Fixed standards set minimum acceptable level
of behaviour
Force of law
Seen as highly protective of public
Proposed customer protection
performance standards in Electricity PUCSL
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Restoring Supplies after a fault:
…..Minimum percentage of supplies to
be connected within 2 hours.
All supplies to be reconnected within 24
hours
Regulatory Strategies
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Weaknesses:
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Prone to capture
Inflexible
Expensive to administer
Incentive is to meet standards, not go
better
Complex rules tend to multiple inflexibles
Regulatory Strategies
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Regulatory Capture;
The pursuit of the regulated enterprises’ interests
rather than those of the public at large
Information Asymmetry
Regulators require a good deal of information in
order to carry out their functions Eg: Fix appropriate
standards, price increases etc.
“the operator knows more about its abilities and
effort and about the utility market than does the
regulator”
Regulatory Strategies
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Self Regulation
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Self-regulation usually involves an organization or
association developing a system of rules that it
monitors and enforces against its own members
High commitment to own rules
Low cost govern
Rules may be self serving
May not represent the interest of consumers
Regulatory Strategies
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Incentive Regulation
“Provide incentive to behave the way that the government
wants”
To deal with information asymmetries regulator can design
and implement incentive schemes that reward the operator
for using its private information to achieve the
government’s objectives.
How could it be done?
Provide the operator with additional units of something it
wants – Eg. Profit
But in turn, operator should give something to the
government Eg. lower prices
Regulatory Strategies
Overall Price Level Regulation:
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Rate of Return Regulation
Price Cap Regulation
Benchmark or yardstick regulation
Rate of Return Regulation
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Tariff = Cost of Production including
Cost of Capital
No incentive to operate efficiently
Operator may over-invest in capital
equipment
Price Cap Regulation
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Permits a utility to increase its overall
level of prices by the previous year’s
rate of inflation (RPI) moderated by a
percentage (X) that reflects the real
cost reduction that the regulator
expects.
RPI - X
Price Cap Regulation
Selling Price Rs 100
20
Profit
Cost of pro.
80
100
30
70
Regulatory Impact
Assessment
RIA - explained
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RIA is used:
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to assess the likely consequences of
proposed regulation, and the actual
consequences of existing regulations
to assist those engaged in planning,
approving and implementing improvements
to regulatory systems
RIA - explained
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Continued…
It is a technique for improving the
empirical basis for regulatory decisions
It systematically and consistently examines
potential impacts (benefits and costs)
arising from government action
It conveys this information to decisionmakers allowing them to consider the full
range of impacts associated with a
regulatory proposal
RIA meets the following criteria
for good policy-making
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Minimizes regulatory capture
Improves understanding of the benefits
and costs of government action
Improves transparency and consultation
Improves government accountability
Origin and Evolution of RIA
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Formalized arrangements for RIA originated in the
USA in 1975
In 1980, two additional countries were using RIA,
Canada & Finland
In 1996, 20 out of 28 OECD countries were using
RIA
Mexico and Korea provide two illustrations from
middle income countries
Countries like Chile, China, Indonesia, Korea,
Malaysia, Peru, Philippines, Thailand and Vietnam
are also considering the implementation of RIA
RIA - the methodology
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It is a continuous process, which can be
seen to consist of three phases:
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Initial RIA – prepared immediately after
the policy idea is generated. Includes pros
and cons of alternatives
Partial RIA – Initial RIA + Greater depth of
consultation with stakeholders
Full RIA – Builds upon the information and
analysis of the partial RIA, and the
complete consultation process
RIA Process
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Identify the policy objective the issue that intend to
address
Identify regulatory and non-regulatory alternative
options, including do nothing/base case
Consider the pros and cons of each option
Identify who is affected, including business sectors
affected
Equity and fairness
Benefits and Cost analysis
Flag up any potential unintended consequences
Consider how to secure compliance
Discussion