Regulatory Governance and Electricity Investment in Developing Countries

1
Regulatory Governance and Electricity Investment
in Developing Countries

• Jon Stern
• London Business School and City University,
  London
• March 2006

2
Regulatory Governance and Infrastructure
Industry Performance

• By 2000, regulatory agencies independent of
  Ministries had been established
• for over 100 countries in telecoms
• for over 50 countries in electricity/energy
• Since 2000, many more have been established and
  many more Ministry regulators operate under
  powers and duties established in a regulatory law
• Has this made a difference to industry
  performance?

3
Regulatory Governance and Infrastructure
Industry Performance Telecoms

• A number of panel data studies for telecoms have
  shown that better quality regulatory governance
• Significantly increases investment in fixed lines
  (Gutierrez 2003 by about 20-30 in long run)
• Significantly increases efficiency as measured
  by labour productivity (Gutierrez 2003 )
• If in place pre-privatisation, an independent
  regulator significantly increases privatisation
  revenues (Wallsten 2003)
• And now, we have the results from similar
  research for the impact of regulatory governance
  on developing country generation capacity per
  head
• (See Cubbin Stern WB Policy Research Working
  Paper No 3535 and WBER forthcoming)

4
Regulatory Governance and its Expected Impact on
Investment

• For commercialised electricity companies (ie
  with private investment or finance of investment
  on commercial terms), we would expect
• Establishment of explicit regulatory framework to
  result in higher investment and capital stock
• The better the regulatory governance framework,
  the larger the expected increase in investment
  and capital stock and
• Larger impacts on investment and capital stock
  over time as the regulator gains experience and
  reputation.
• Are these confirmed when tested?

5
Data Used to Test Impact of Regulatory Governance
I

• We have data on generation capacity (MW) for 28
  developing countries for a 21 year period
  1980-2001
• 15 Latin American countries, 6 in Caribbean, 4 in
  Asia and 5 in Africa.
• Of the 28 countries, 26 had passed an electricity
  regulatory law by 2001 but only 5 before 1995
• By 2001, 17 countries had an autonomous regulator
  (all with a regulatory law) and 12 countries had
  a Ministry regulator (all but 2 with a regulatory
  law)
• Almost half the autonomous regulators were under
  3 years old in 2001 (including all the African
  ones) while around 30 were over 10 years old
• The median age (50 point) of the autonomous
  regulators was just under 5 years in 2001

6
Data Used to Test Impact of Regulatory Governance
II

• We also had regulatory data on
• Whether the regulator (Ministry or autonomous)
  was funded by licence fees or from central
  government funds
• Whether the regulator was obliged to pay staff on
  civil service pay scales
• The year in which the regulatory law was enacted
• (All the regulatory data came from Preetum Domah
  2001 survey)
• Other data used
• GDP, population, debt levels, industry value
  added
• Country governance variables
• Henisz et al dated information on privatisation
  (minority, majority and full) and competition

7
Measures of Regulatory Governance

• For our 4 governance indicators with known
  starting dates Law (Yes/No), Autonomous
  Regulator (Yes/No), Licence fee funding (Yes/No),
  non-Civil Service Pay Scales (Yes/No), we can
• Test effect of each individually OK as staring
  point but leads to over-estimate of effect of
  each
• Combine in a regulatory index for regulatory
  index, each country is scores either Zero or 1,2,
  3 or 4 in each year
• A country switching from standard, centrally
  funded Ministry regulator to autonomous, licence
  fee funded regulator in 1995 is scored zero on
  the Index from 1980 to 1995 and either 3 or 4
  from 1996 through 2001
• Both measures provide useful information

8
Estimation Method

• Since we have data for 28 countries over 20
  years we can use panel data methods to estimate a
  fixed effects model.
• What does this mean?
• It means that for each country, we can estimate
  a country specific fixed effect which captures
  all the particular features of that country
  relevant to energy use (eg climate, fuel use,
  etc), institutional quality (courts, corruption,
  etc)
• Resulting estimates show impact of regulatory
  governance on generation capacity investment
  controlling for observable and unobservable
  country specific determinants of generation
  investment

9
Main Electricity Regulatory Governance Results

• Regulatory governance does matter
• In long-run (ie after about 10 years or more),
  best quality regulatory governance associated
  with about 15-20 higher generation capacity per
  head
• Each 1 point increase in index implies 4-5
  increase in generation capacity per head in long
  run
• But, effects take time to build up
• Very little effect for 1st 3 years, under half
  final effect after 5 years
• Biggest single impact from having a regulatory
  law in place, followed by licence fee funding
• Autonomy of regulator less powerful may be
  consequence of high proportion of only recently
  established autonomous regulators

10
Results on GDP Level, Privatisation, Competition
and Country Governance

• A 10 increase in real GDP per head (exchange
  rate basis) associated with a 7-8 higher
  generation capacity per head in long run
• Majority or full privatisation associated with
  12-20 higher generation capacity per head in
  long run
• Competition legal right for IPPs to generate
  for resale associated with 14 higher generation
  capacity per head in long run
• Both particularly competition variable - may
  primarily reflect countrys commitment to
  electricity reform
• Country governance important but not hugely
• CHECKS political risk index significant but much
  smaller effect than electricity regulatory
  variables
• Weak evidence of some effect of Kaufmann Rule of
  Law index

11
Implications of Results

• How should we interpret these results?
• The results mean that an average developing
  country with an average fixed effects score could
  expect enough extra investment to give 15-20
  higher generation capacity per head after about
  10 years
• This would be with an average quality law, a
  regulator with an average staffing levels,
  average country governance, etc and an average
  (unobservable) fixed effects score
• Countries with above average quality laws,
  staffing levels, country governance, etc could
  expect larger impacts than 15-20
• Countries with below average quality laws,
  staffing levels, country governance, etc should
  expect smaller impacts than 15-20

12
Final comments

• The results provide strong empirical support for
  arguments that good electricity governance
  genuinely matters in practice for electricity
  generation investment levels
• Results stood up with extensive testing of
  variants and of statistical assumptions
• Confirms results from case studies
• Other results suggest that better regulatory
  governance improves generation availability but
  only by a small amount
• Efficiency effects also likely to be present but
  we couldnt test
• Institutions matter in practice particularly
  their design and governance quality
• This is true not just for electricity. This has
  been shown to be true for economic growth, for
  telecoms and for other industries with high
  capital requirements and sunk costs.

13
Links to Supporting Papers

• Main Paper discussed
• Cubbin, J.S and Stern J., (2004), Regulatory
  Effectiveness The Impact of Good Regulatory
  Governance On Electricity Industry Capacity And
  Efficiency In Developing Countries  
• http//papers.ssrn.com/sol3/papers.cfm?abstract_
  id695385
• Final version World Bank Economic Review
  forthcoming, with (paid-for) online availability
• See also
• Stern, J. and Cubbin J.S. (2003), Regulatory
  Effectiveness The Impact of Regulation and
  Regulatory Governance Arrangements on Electricity
  Outcomes A Review Paper
• http//papers.ssrn.com/sol3/papers.cfm?abstract
  _id695386