Policy Reform, Vol. 1, pp. 357-387, 1996
16 Pages Posted: 25 Jul 2007
Risk, whether market or political, is an important determinant of private investment decisions. One important risk, subject to control by the government is the risk associated with the hold-up problem: governments can force utilities to shoulder burdensome taxes, to use input factors ineffectively, or to change unprofitable rates for their service. To attract private investments governments must be able to make commitments to policies that are nonexpropriative (either to contracts that guarantee very high rates of return or to favorable regulatory policies). These commitments, of course, must be credible.
Judgments about the credibility of commitments to regulatory policies are based upon two political factors: regulatory predictability and regime stability. Regulatory predictability implies that the regulatory process, in which prices and levels of service are set, is not arbitrary. If the condition of regulatory predictability holds, then investors can forecast their returns over time and hence can calculate the value of their investment. If there is regime stability, then there is minimal risk of wholesale changes in the way the government regulates the industry- the most extreme type of change being the denial of property rights, or expropriation. We argue that three characteristics of the regulatory process are, in turn, important determinants of regulatory predictability: agenda control, reversionary regulatory policy, and veto gates. Moreover, regime stability is also, in part, a function of these three characteristics. We examine our theory of political risk and regulatory commitment by comparing the cases of Argentine and Chilean electricity investment and regulation.
Keywords: Utility regulation, Hold-up problem, political risk, regulatory commitment, regulatory predictability, Argentina, Chile
JEL Classification: L94, N46, K23
Suggested Citation: Suggested Citation
Heller, William and McCubbins, Mathew D., Politics, Institutions, and Outcomes: Electricity Regulation in Argentina and Chile. Policy Reform, Vol. 1, pp. 357-387, 1996. Available at SSRN: https://ssrn.com/abstract=1002955