Utility Market Reforms

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In the early and mid twentieth century many countries, especially in the developing world, sought to provide utility services by forming state-owned monopolies. By the latter part of the century, it became clear that state-owned monopolies were generally inefficient providers of utility services and ineffective in making these services broadly available to the public.

Micro-management from politically-motivated government officials led state-owned operators to have excessive numbers of employees, provide service primarily to politically powerful groups, cross-subsidize services, and charge non-commercially-viable prices.

Weak institutions allowed two types of political opportunism. In some instances, prices were kept artificially low so that state-owned operators needed government subsidies to finance investments and cover other costs. If fiscal constraints prevented the government from providing the subsidies consistently, then there was under investment and poor service quality. In other instances, the utility services would be used as cash cows to fund other government functions. This also resulted in under investment and poor service quality for the utility services.

During the 1980s and 1990s, policy makers began to conclude that regulated, privately-owned service providers might be more effective than state-owned operators because private operators might be less subject to political opportunism and might operate more efficiently than state-owned enterprises, especially if subjected to competitive pressures, because profit motives provide clear and consistent incentives to control costs, deploy infrastructure where demand is sufficient to cover costs, offer prices that encourage efficient utilization of the infrastructure, and innovate when customers find the innovation sufficiently valuable to pay for the improvement.1 As part of this trend, countries began to introduce competition wherever possible and developed utility regulatory agencies that would enforce concession or licensing agreements and regulate prices.2

The shape of market reform has varied across sectors and countries. In telecommunications, liberalization and privatization have been the most prevalent features of market reform, although countries have varied in their degrees of market liberalization and privatization. Telecommunications regulators and policymakers have generally focused on removing barriers to entry, ensuring efficient network interconnection,3 rebalancing prices4 to reflect new competitive realities, and promoting access to telecommunications for the poor and in rural areas.5 In electricity, industry restructuring6 and commercialization (sometimes through privatization) have been the most prevalent market reforms. Restructuring has sometimes involved structural separation that separates the sector into competitive generating companies and monopoly transmission and distribution companies. Establishing efficient market mechanisms for electricity has been particularly challenging. Markets for natural gas have experienced reforms along the lines of some electricity reforms – production and transport are separated from distribution, gas production has been opened to competition, and gas distribution is typically left to a local monopoly. Water reforms have varied greatly, ranging from complete privatizations as in the case of the U.K., to build-operate-transfer arrangements, to private management contracts, to incentive systems for state-owned monopolies.7

Footnotes

  1. The references in the Rationale for Reform of Utility Markets section note these trends.
  2. Monopoly and Market Power examines the regulation of monopolies. The Regulatory Instruments section of the first chapter provides information on various regulatory instruments, such as license and concession agreements, as does the Development, Review, and Appeal of Regulatory Rules and Decisions section.
  3. Competition in Infrastructure Markets covers market liberalization, including barriers to entry and interconnection.
  4. Tariff Design covers tariff issues.
  5. Economics of Alternative Price Structures and Pricing for the Poor cover issues of providing service to the poor.
  6. Competition in Infrastructure Markets covers approaches to market restructuring. Rationale for Reform of Utility Markets in the first chapter examines the motives for restructuring.
  7. Incentive mechanisms are covered in Price Level Regulation and Quality, Social, Environmental.