Utilities Policy 8 (1999) 33–50

www.elsevier.com/locate/utilpol

Regulatory governance: criteria for assessing the performance of

regulatory systems
An application to infrastructure industries in the developing
countries of Asia
a,b,* b
Jon Stern , Stuart Holder
a
London Business School, London, UK
b
NERA, 15 Stratford Place, London W1N 9AF, UK

Received 1 September 1998; received in revised form 22 January 1999; accepted 1 March 1999

Abstract

This paper discusses the main issues affecting the regulatory governance of infrastructure industries and their implications for
regulatory practice. The discussion covers the need for economic regulation under both state ownership and private ownership, as
well as issues of regulatory commitment, including the role of concession contracts. It then discusses the theory of regulatory
governance and its implications for institutional design. On the basis of this discussion, we derive a set of six criteria for appraising
the performance of regulatory frameworks for infrastructure industries. These criteria are then applied to a set of twelve infrastructure
industries in six developing Asian countries and we report the results of the appraisal, including trends towards convergence of
regulatory frameworks and the implications for private investment. Among our main conclusions are (i) the importance of structural
liberalisation as a catalyst for developing good practice regulation; and (ii) the importance of transparency for effective regulation.
 1999 Elsevier Science Ltd. All rights reserved.

Keywords: Regulation; Regulatory Governance; Infrastructure; Private Investment; Asia; Evaluation

1. Introduction institutions, was almost entirely an issue affecting the

The age of utility regulation is here. All over the
world, countries are creating new institutions to provide
for the economic regulation of their utilities. Sometimes
they are independent regulatory agencies, sometimes
they are departments within Government Ministries and
sometimes they are semi-independent bodies or inde-
pendent advisory agencies. In spite of the various predic-
tions that such regulation would be a temporary phenom-
enon in the short period before the establishment of
competition and that regulatory agencies would wither
away, there is no sign of that yet happening anywhere
in the world.
Before 1980, economic regulation of utility industries,
at least the theory and practice of specific regulatory
* Corresponding author. Tel.: ⫹ 44-171-629-6787; fax: ⫹ 44-171-
493-5937; e-mail: jon.stern@nera.com
US. Since 1980, in country after country, the unbundling
and/or privatisation of utilities has led to the emergence
of new regulatory institutions. This path was led by the
telecommunications and electricity industries, but has
since spread to a range of other infrastructure industries
including natural gas, railways, water and sewerage, etc.
From 1980, there was a wave of utility privatisations
in the UK, starting with telecommunications in 1984,
which led to the establishment of a series of independent
regulatory offices starting with OFTEL. In the UK and
elsewhere, governments established autonomous agenc-
ies to regulate their utilities, agencies that were estab-
lished by law as separate from Ministries and indepen-
dently funded. In Scandinavia, the introduction of
competition into electricity and telecommunications led
to the establishment of new regulatory agencies. The
European Union (EU) telecommunications Directives
now require EU member states to establish an inde-
pendent regulator for the sector. These new West Euro-

0957-1787/99/$ - see front matter  1999 Elsevier Science Ltd. All rights reserved.
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34 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
pean regulatory institutions have usually, but by no
means always, been associated with privatisation.
This is not just a phenomenon of rich countries. Latin
America has seen a series of more or less independent
regulatory agencies set up over the last 15 years. Follow-
ing this path, there have been attempts at developing
regulatory frameworks in a number of Central and East
European (CEE) economies, in Asia and, most recently,
in Africa. Again, the path has been led by telecommuni-
cations and electricity, but with other industries now
increasingly considering, and, in some cases, instituting
explicit regulatory frameworks as private investment and
asset ownership develop in these industries. However, as
yet, most (but not all) of the new frameworks in this
last group of countries involve only a limited degree of
decision-making powers and independence for the new
regulatory bodies.
For the most part, these new regulatory institutions
operate as part of the process of commercialising the
provision of utility services, typically including a sig-
nificant involvement of private capital. But, regulation
can (and frequently is) used by governments as a substi-
tute for taxation, e.g. as a way for governments to
impose and fund social and environmental objectives
from the consumers of commercialised and privatised
utility services. Indeed, such obligations have for many
years been a major part of traditional state dominated
infrastructure development with pervasive subsidies and
cross-subsidies, but, the introduction of private capital
has forced governments to make these obligations much
more explicit. Such obligations have traditionally been
particularly important for energy and for water services,
particularly where national coverage has been much less
than complete and governments have wished to impose
service expansion obligations on service providers.
Sometimes independent regulators are required to
manage such obligations, e.g. free local call obligations
in US telecommunications. This can create serious ten-
sions where the introduction of independent economic
regulation is to support and sustain commercialisation,
e.g. as to whether the utilities are allowed full cost recov-
ery. Nevertheless, even here regulation can be used to
promote transparency in the provision of social and
environmental objectives and in the provision of cross-
subsidies (e.g. via the use of universal service
obligations). Such developments are particularly likely
the larger the number of companies operating in the
potentially competitive elements of utility industries.
Similarly, new regulatory agencies are used by
governments in developing countries to monitor and
enforce investment commitments by private (particularly
foreign) investors. This may be through contracts with
the domestic utility (e.g. joint ventures, independent
power producers, etc.); or, alternatively, through prepar-
ing and supervising concession agreements of various
kinds.
Although the primary objectives relating to the main-
tenance of private investment are usually clear, the new
regulatory agencies also have to be able to cover a very
diverse range of secondary regulatory objectives. They
also have to address the needs of a wide range of indus-
tries and of economic and market structures. They have
to be able to operate in countries with very different lev-
els of income and human resource capabilities. Finally,
and probably most importantly, the enormous range of
ideological, political and legal contexts means that regu-
latory institutions have to be designed to operate effec-
tively across countries with very different needs and
backgrounds.
In consequence, it is crucial that the design of regulat-
ory systems in different countries distinguishes care-
fully between:
1. the objectives of infrastructure regulation—its pur-
poses and functions; and
2. the specific institutional framework for regulation in
any given country.
In what follows, we will place considerable emphasis on
the need to be very clear about the underlying objectives
and requirements of effective regulation; but, to be flex-
ible and creative about institutional frameworks and
forms in any particular country and/or industry. These
two aspects make up the core content of discussions of
regulatory governance. The first aspect is concerned
with the theory of regulatory governance; the second
aspect is concerned with the practical design aspects of
regulatory frameworks.
The US model of regulation operates in a country with
a strong and very well-established constitution, an
administrative law code and a tradition of using court
cases to resolve all manner of issues. This is vastly dif-
ferent from the UK, where (notoriously), there is no for-
mal constitution, no formal code of administrative law
and a tradition of aiming at compromise between parties
rather than reaching for the law-courts. In other EU
countries, regulatory systems have to operate within
Napoleonic law codes and within traditions of activist
states and strong public service obligations. In CEE
economies, they operate in the legacy of recently swept-
away centrally planned, Communist systems.
The result of these developments is that increasing
attention has been given both to the theory and to the
practice of regulatory governance in different environ-
ments. This has been reflected in the development of an
academic literature and by a wide range of publications
from the World Bank, the Asian Development Bank and
others on how countries can develop their regulatory
institutions.
The purpose of this paper is to discuss the main issues
arising from some recent theoretical literature in this area
and its implications for regulatory practice. This pro-
vides the basis for assessing the performance of regulat-
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
ory frameworks in different countries and industries. The
conclusions of this analysis are illustrated with reference
to a recent survey of regulatory governance in the infra-
structure industries of developing Asian economies, car-
ried out by NERA for the Asian Development Bank
(NERA, 1998).
The structure of the paper is as follows. In Section 2,
we discuss the need for economic regulation in infra-
structure industries and how this need is met in state-
owned and privately owned utilities. In Section 3, we
discuss regulatory commitment and its implications for
regulatory governance as well as the potential role of
concession contracts for regulatory commitment. Section
4 provides an exposition of regulatory governance, its
implications for institutional design and regulatory pro-
cesses and practices and the concepts of formal and
informal accountability. From this discussion, we derive
our six criteria for appraising regulatory systems. Section
5 concludes the paper with an application of these
appraisal criteria to 12 infrastructure industries in
developing Asian economies. We report the main results
and discuss trends, including trends towards conver-
gence of regulatory frameworks, and the implications for
private investment in Asian developing countries’ infra-
structure.
2. Key issues in regulatory design
2.1. Economic regulation of utilities
In this paper, regulation is discussed in terms of the
economic regulation of infrastructure industries. The
industries discussed—electricity and natural gas, tele-
communications, railways and other transport industries,
water and sewage—are all mass-market network indus-
tries. In most cases, the networks involve explicit physi-
cal networks (electricity, railway lines), although in other
cases the infrastructure is of hubs or nodes in communi-
cation networks (ports and airports). It is useful to term
these industries as utilities.
We define the economic regulation of utilities as
covering issues such as:
쐌 pricing;
쐌 investment/costs of service;
쐌 quality (including service standards and service
obligations); and
쐌 the rate or return on assets.
We exclude issues such as environmental standards,
health and safety at work, etc. Utilities may well face
regulation in these areas, but the role of economic regu-
lation is to incorporate such requirements in decisions
affecting the variables above rather than to decide on the
chosen level of standards or the method of regulation.
35
2.1.1. The need for the economic regulation of
infrastructure industries
The infrastructure industries that we discuss all, to a
greater or lesser extent, share the following three charac-
teristics (see Cave and Stern, 1998, following Levy and
Spiller, 1994):
쐌 They are highly capital intensive. The assets required
are long-lived and, in many cases, the assets once
installed are sunk assets, in the sense that they cannot
be sold or redeployed elsewhere. In consequence,
investors in these industries are making a hostage to
fortune when they invest. They are therefore exposed
to the risk of strategic behaviour, particularly by
governments, who can readily capture the value of the
investments once they have been installed and expro-
priate their owners, e.g. by failing to allow the mainte-
nance of prices in real terms or reneging on explicit
or implicit contracts.
쐌 The industries are characterised by considerable econ-
omies of scale. These place a considerable limit on the
number of firms that can be supported by the market,
sometimes only allowing a single firm—as with local
distribution networks and sometimes for
transmission/transport networks. Hence, governments
cannot rely on the operation of competitive markets to
police behaviour and prevent the abuse of monopoly
power. For some such industries, the problem is
exacerbated by the existence of economies of scope
(e.g. in the provision of different telecommunications
services, in metering and billing, etc.).
쐌 Utility services (most obviously water, energy and
transport, but increasingly telecommunications) are
consumed by and necessary to the welfare of all
households. Hence, the prices of such commodities
are highly political. Cost-based prices for small con-
sumers can represent a substantial proportion of
household budgets, especially for low income house-
holds. Price changes for such goods (e.g. the abolition
of cross-subsidies) can therefore have a considerable
impact on the level and distribution of real incomes.
In addition, since these services are critically
important intermediate inputs for other sectors of the
economy, their service levels and prices are of major
importance for industrial costs and international com-
petitiveness. These considerations can give govern-
ments a powerful incentive to behave strategically
towards private investors in such industries.
These three characteristics both make economic regu-
lation a necessity for utilities and make it difficult and
fragile.
The difficulties with economic regulation can be side-
stepped by state-ownership. Indeed, state-ownership
with the government taking responsibility for the invest-
ment and financial viability of utilities is the fall-back
method of economic organisation of infrastructure indus-
36 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
tries. It may not be efficient and it may not guarantee
continuous supply, but it does enable all countries to
construct basic networks.1 It also allows these industries
to develop and operate on a non-commercial basis and
hence means that no explicit arrangements for economic
regulation are necessary. This is different even when
utility services are provided by commercialised, profit
making state-owned corporations and different again
when they are provided by private companies. In the last
case, the need for explicit and well-designed regulatory
institutions is unavoidable.
These issues are discussed in more detail in Section
2.2 and 2.3 below which deal respectively with econ-
omic regulation with state ownership and with private
ownership of utilities.
2.2. Regulation and state ownership
Although independent regulation is largely synony-
mous with private ownership, regulation per se is present
in all utilities whether state or privately owned.2 In all
countries, some institution regulates investment and
prices of the main utility services. The process of regu-
lation may not be separate from other functions; in parti-
cular, it may not be separate from policy making.
Economic regulation of utilities may be carried out by
Ministries or Prime Ministers, Presidents or ruling party
secretariats. It may be regulation of prices and invest-
ment on a non-commercial or anti-commercial or even
on a completely incoherent basis. However, govern-
ments can no more escape the need for regulating the
economic performance of utilities than Monsieur Jour-
dain in Moliere’s play “Le Bourgeois Gentilhomme”
could escape talking prose—even though he did not
realise he was talking prose until it was pointed out to
him by his teacher of rhetoric. The inescapable need for
regulating utility prices and investment holds even for
state-owned enterprises in the most centrally planned
economies.
In centrally planned economies, and also in heavily
corporatist systems as found in some developing econ-
omies (including many Asian developing economies),
the economic regulation of utilities is carried out by
Ministries. Sometimes, it is the responsibility solely of
the “line” Ministry (the Ministry of Industry, the Minis-
try of Energy, the Ministry of Communications); some-
1
We recognise that some commentators may disagree with this
view, but it seems not only theoretically well-based to us (see Levy and
Spiller, 1994, pp. 241–242) but also strongly confirmed empirically.
2
In Norway and other Scandinavian countries, independent regu-
lation is present with non-private ownership and competition (e.g. in
Norwegian electricity and Swedish telecommunications and posts).
But, this frequently involves municipally owned companies which are
required to operate on a commercial basis rather than large companies
owned by central governments.
times it is the joint responsibility of the line Ministry
and the Ministry of Finance and/or other agencies. In
many cases, the line Ministry may have the responsi-
bility but little power. De facto, the utilities often domi-
nate the line Ministries and achieve a substantial degree
of regulatory capture. This is particularly likely if the
country is trying to build-up a strategic “national cham-
pion” energy company, telecommunications or other
utility. In other cases, the line Ministry may be the agent
of political decisions made by figures central in the polit-
ical structure (e.g. the Presidential office).
The most obvious point about such regulatory systems
is their opaqueness. The three main functions affecting
infrastructure enterprises:
쐌 policy making;
쐌 ownership and management;
쐌 regulation.
are carried out by the same agency(ies) and are not func-
tionally distinguished. Hence, the process of regulation
tends to become a shifting set of negotiations between
the players. Regulation, and end-user pricing in parti-
cular, tends to become highly politicised.
The consequence is that the utilities tend not to oper-
ate in a commercial way, but that any financial targets
are set in terms of financing current expenditures and
that household and/or small agricultural consumers pay
heavily subsidised prices. This pattern is readily observ-
able in developing Asian economies. Sometimes, as most
notably with the Indian State Electricity Boards, the util-
ities are chronically loss-making. In other cases, as with
Indonesian and Malaysian energy and telecommuni-
cations companies, they are not loss-making but are rela-
tively high cost, earn a low real rate of return on assets
and have pervasive cross-subsidies.
2.3. Regulation and private ownership
In most developing Asian economies, as in most coun-
tries outside North America, utility services have, over
the last 50 years, typically been provided by state-owned
vertically integrated monopolies. There have been
exceptions (e.g. electricity distribution in the
Philippines) but, in general, the norm has clearly been
for heavy state involvement, typically at national level
but sometimes with state-level or local involvement (e.g.
in India).
The accompanying highly politicised system of regu-
lation applied to many state-owned utilities is not appro-
priate when private sector investment is introduced. It
clearly violates the requirements of effective regulatory
governance set out in Section 2.1 above.
In order to signal that the utilities being privatised (or
to which private capital is being attracted) will not be
subject to arbitrary political interference that will under-
mine their commercial viability, the establishment of a
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50 37

credible independent regulatory agency has become a 2.4. Regulation of infrastructure industries with
standard feature of the privatisation process in Europe competition over networks
(particularly in Central and Eastern Europe), in Latin
America and, increasingly, in Asia.3 This provides the Privatisation of state-owned utilities has often been
signal by which private investors, particularly foreign accompanied by significant restructuring of the affected
investors, are reassured that they can expect to earn a industries. Rather than simply transferring a monopoly
reasonable real rate of return. This, in turn, means supplier to the private sector, governments have sought
governments can sell their shareholdings at a higher opportunities to introduce competition into previously
price and economies with credible regulatory agencies monopolised industries. This introduces additional com-
can attract capital more easily and at a lower cost. plications to the nature of the necessary regulatory
The main aspect of independence that is usually framework. Most of these complications are beyond the
emphasised is independence from government, although scope of this paper. We will, however, make two
independence also encompasses independence from the points here.
regulated companies and from populist consumer press-
1. The task of regulation for unbundled utilities is
ures. In the UK as elsewhere, the degree of independence
clearly very different from the task of a regulator of
is never absolute as governments always retain some
a vertically integrated monopoly utility as it evolved
powers, including emergency powers, and appoint regu-
in the US. It means that the regulatory framework
lators.4 Nevertheless, a good test for the degree of inde-
ensures that different companies in the industry are
pendence is to consider (a) the extent of such powers,
all treated fairly, e.g. as regards access to and the
(b) how clearly they are defined in the regulatory law
price for natural monopoly network services.
and (c) the obligations on government to publish and
2. With unbundled industries, the independent regulator
justify the use of such powers.
is the key arbitrator. The regulatory agency essen-
Governments that introduce credible regulatory insti-
tially becomes a specialist competition agency (as
tutions reduce the cost of capital to regulated infrastruc-
well as a traditional utility regulator).6 As well as
ture industries by reducing regulatory risk. However, this
ensuring fair and sustainable competition, however,
regulatory credibility has to be constantly sustained.
it will also need to ensure that the benefits of compe-
Governments can be tempted to intervene with inde-
tition are widely distributed, and that services con-
pendent regulatory agencies when they dislike the
tinue to be readily available to all potential con-
results. This can produce crises of credibility, as to some
sumers.
extent occurred in Hungary in 1996 when the govern-
ment found ways to reduce the price rise recommended
3. Regulatory governance and private investment:
by the Hungarian Energy Office while staying within the
commitment issues
letter of the Electricity Law.
The requirements to sustain private investment and
Although economic regulation exists in state-owned
ownership as set out above are in considerable contrast
as well as privately owned infrastructure industries, the
to the opaque regulatory systems outlined in Section 2.2.
concerns of regulatory governance and the development
Those regulatory frameworks are not conducive to priv-
of explicit regulatory frameworks primarily relate to the
ate investment except at high cost, either in terms of the
issue of how private investment can be encouraged
required rate of return (or through related means such
and sustained.
as strong front-end loading of returns and take-or-pay
This issue is at the heart of the literature of the last
contracts) or via sovereign guarantees (or equivalents).
10–15 years. Indeed, the aim of the seminal 1994 paper
In particular, separating regulation from policy and own-
of Levy and Spiller on the theory and practice of regulat-
ership issues is essential to sustain private capital invest-
ory governance is precisely to focus attention on the
ment flows on reasonable terms.5
regulatory arrangements necessary to sustain private
investment and how these vary according to the insti-
3
In Central and Eastern Europe (and elsewhere), the degree of tutional endowment in different countries. In this per-
seriousness with which genuinely independent regulatory institutions spective, as suggested in Section 2.1 above, if countries
have been established is very variable (see Cave and Stern, 1998,
p. 19 and the references cited in that paper). However, the issue has
been important—and increasingly important—in non-voucher privatis- ably attractive before the Asian crisis. However, it seems much less
ations, namely electricity privatisation in Hungary and Poland. convincing in the light of the post-1997 fallout to infrastructure pro-
4
We are grateful to an anonymous referee for emphasising this jects and investment in Asia (most obviously in electricity), e.g. in
point, with which we strongly agree. Indonesia, Pakistan, and even China. These issues are discussed in
5
The view expressed above may be challenged on the grounds that more detail in subsequent sections of the paper.
6
the alternatives (including concession contracts) may be easier to achi- In some cases (e.g. Australia at the Federal level, Austria and
eve and more credible in some environments. The alternative view (as Germany), the competition agency also has the responsibility for regu-
expressed to us by an anonymous referee) may have seemed reason- lation of some or all utilities.
38 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
are unable or unwilling to create and sustain effective
regulatory governance arrangements, state ownership
and finance of infrastructure industry investment
becomes the fall-back solution (see Levy and Spiller,
1994, p. 242).
The core issue is to identify the features needed by a
regulatory system to support private investment in
(and/or private ownership of) infrastructure industries
which are highly capital intensive, have considerable
economies of scale (particularly from network elements)
and which are providers of services that are essential
commodities both for household welfare and as inputs
for companies.
In addition, in terms of its outputs, the regulatory sys-
tem should also:
1. ensure the efficient provision of services to con-
sumers at the minimum necessary price; and
2. support private investment by continuing to allow
companies the reasonable expectation of a normal
real rate of return.
The underlying problem is that it is infeasible to write
time-consistent, enforceable long-run contracts for the
necessary period ahead that can cover all of the neces-
sary contingencies. This is particularly the case, when
such contracts would involve multiple parties, invest-
ment in sunk assets and which would need to include
politically accountable governments (which cannot leg-
ally bind their successors).
The standard economic solution proposed to handle
this problem is the regulatory contract. The regulatory
contract described in the theoretical literature should be
thought of as an implicit rather than an explicit (or for-
mal legal) contract.7
The regulatory contract is an implicit principal-agent
contract under which:
쐌 the regulator acts as agent for its principals
(customers);
쐌 the government acts as the agent for its principals
(citizens); and
쐌 the management acts as agent for its principal
(stockholders and investors).
In addition, the government has a crucial role in under-
pinning the regulatory contract and the regulator. The
government:
7
See Section 3.1 below for a short discussion of concession con-
tracts and their relation to the underlying regulatory problem. An
anonymous referee has pointed out that some authors (including C.
Veljanovski) have argued for an explicit and formally written-down
regulatory contract. This is an interesting (if problematic) idea, which
raises some very wide issues. As it has not been either proposed or
adopted in any Asian economy (nor, to the authors’ knowledge,
adopted anywhere in the world), we do not discuss it further in this
paper.
쐌 needs to provide and sustain the legal framework
under which the regulatory operates; and
쐌 needs to support enforcement of the regulatory frame-
work and the “rules of the game”.8
Formally to solve the underlying problem requires an
enforceable regulatory contract which is invulnerable to
post-contractual opportunism and, hence, is relatively
explicit. But, this would require limits on sovereignty
(e.g. extra-territorial appeals and enforcement) that
governments are only willing to accept in extreme cir-
cumstances. Hence, in practice, the problem cannot be
“solved”; it can only be more or less imperfectly man-
aged.
In consequence, regulatory processes are fragile in all
countries, including the most developed. They are parti-
cularly fragile in countries with relatively insecure or
embryonic parliamentary and legal systems, especially
in highly politicised countries with no tradition of
enforcing the separation of powers (like some
developing Asian economies). But, paradoxically, these
are the countries where reputational concerns mean that
there is greatest need for a secure regulatory process.
An additional problem is that regulatory agencies are
only as reputationally sound as their last decision. Econ-
omic regulation is, in technical economic terms, a
repeated non-zero sum game. Hence, reputation is cru-
cial for achieving a stable and positive solution. It takes
much time and effort to establish a reputation for fair
regulation. Conversely, it can take only one or two par-
tial decisions or government interventions to seriously
undermine a good regulatory reputation.9
3.1. Concession contracts: regulatory commitment
through long-term contract
An explicit long term contract provides an alternative
way of supporting private sector investment in infra-
structure industries. Such contracts will, for instance, set
out both the obligations of the privatised company or
private investor (for example, in terms of service roll-
out and performance standards), as well as the tariffs
which it will be allowed to charge and/or the basis for
revising the tariffs. Contracts of this type are common
in the water and sewerage industries and in transport,
particularly for road and rail and are frequently associa-
ted with major construction contracts. They are, how-
ever, becoming more common in the energy industries,
e.g. with distribution concessions.
Such arrangements are frequently found in France and
Francophone countries (such as Francophone West
8
See Stern, 1997, for a discussion of the importance of informal
accountability and the “rules of the game”.
9
See Stern, 1997, for further discussion of the importance of regulat-
ory reputation.
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
Africa). They appear to fit readily into a French legal
framework. They are also more consistent with the tra-
ditional French policy view that the provision of public
services can be conceded by the state but that the pro-
vision of public services should not be sold in perpetuity
to the private sector.
Concession and related contracts allow a considerable
degree of independence from Ministries through the
establishment of an arms-length relationship. They there-
fore attempt to provide some guarantee against arbitrary
political interference by governments through the cre-
ation and establishment of an explicit contractual
relationship. In addition, if the contract embodies some
regulatory principles (e.g. on tariff revision) this can pro-
vide some protection against regulatory opportunism.
For instance, they may allow for international arbitration
in cases of dispute between the host government and the
concession holder.
The difficulty with such contracts is that it is imposs-
ible for them to be other than seriously incomplete. They
are therefore very vulnerable to attempts by any of the
parties to renege on key terms or fundamentally change
them in the light of unforeseen circumstances. Being
explicit contracts, the potential gains and benefits of
time-inconsistent behaviour may be rather more obvious
than with an implicit regulatory contract which has an
independent regulatory agency as the core mediating
agency.
The core regulatory governance issue with concession
contracts is therefore whether:
1. the long term contracts are intended to be a substitute
for a separate regulatory institution (e.g. if the con-
cession contract attempts to specify tariffs and per-
formance standards for the entire contract period); or
2. the long term contract is used as a complement to
a separate regulatory institution, providing an agreed
basis for regulation (e.g. with clauses on how the
regulatory aspects may be reopened and revised by
the parties, appeals procedures, penalty clauses, etc.).
The problems typically arise when the underlying pro-
jections for the concession prove over-optimistic. This,
however, is a general problem. Problems can also arise
when the concession turns out to be far more profitable
than expected. This can lead to formal or informal press-
ure on the operator to agree to price reductions, service
quality improvements or other variations to the terms of
the original contract.
The arguments on regulatory commitment outlined
above would suggest that, in general, particularly for
foreign investment, lodging concession contracts within
a separate regulatory framework is a superior solution to
trying to use them as a substitute for separate regulation.
Explicit contracts can provide a useful underpinning for
the implicit regulatory understanding while avoiding the
dangers of relying too heavily on an incomplete binding
39
contract negotiated in circumstances of considerable
uncertainty.
The basis for these claims is that relying solely on the
concession contract represents a search for “too much”
certainty. Conversely, if there is a regulatory framework
agreed within the concession contract, this can be used
as the basis for setting up a process under which the
terms of the contract will be revised according to pre-
viously agreed and laid-down criteria. If there is no such
agreed review procedure, any reopening is much more
likely to generate a direct renegotiation between the
government and the concessionaires. Given the enor-
mous difficulties of writing (let alone rewriting) time-
consistent, enforceable long-run contracts for a long per-
iod ahead that can cover all the necessary contingencies,
eliminating any mediating regulatory agency is likely to
place too much strain on the concession agreement.
The degree of strain and, hence, the potential for rely-
ing solely on the long term contract, are clearly less the
lower the commercial uncertainty for the supplier. Thus,
it is lower for any industry:
1. the more predictable is demand for its output and,
in particular, the lower are its own-price elasticity of
demand and close cross-price elasticities; and
2. the more well-established is its technology and the
more predictable is its cost structure.
These conditions look plausible for water and sewage
and for energy distribution. They look far less plausible
for roads and railways where demand forecasting can be
very difficult, price responses can be sizeable10 and
where construction costs can be subject to massive
uncertainties. Hence, it is not surprising to find major
problems with (and, not infrequently, collapses of) con-
cession contracts for road and rail services, e.g. road
contracts in Thailand and elsewhere (including the initial
contract for the high-speed rail link between London and
the Channel Tunnel). In the latter case, the problems of
major construction cost risk plus considerable demand
risk for the services plus conventional regulatory risks
proved too much to sustain a private sector investment
contract for the project without a major increase in sub-
sidy.
The other main cases in which concession contracts
can substitute for regulatory agencies are:
1. in countries where the market is sufficiently large and
growing rapidly where concession contracts can be a
useful instrument, particularly where the local legal
10
For roads, it is the cross-elasticity between the price of the new
road and the price (usually zero) on alternative, existing road routes
that is critical.
40 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50

system is not well-suited to (or experienced in) hand- The difficulty of sustaining concession contracts in the
ling commercial or regulatory issues;11 and face of foreign exchange risks discussed above is one
2. in countries where the constitutional and political sys- aspect (and a good example) of the underlying problems
tems allow for major changes in government and in in defining effective and binding long-term regulatory
enacting new primary legislation, but where legal contracts. In particular, they demonstrate the problems
process are secure and efficient (e.g. some Carib- in trying to use contracts to substitute for autonomous
bean countries). regulatory agencies. As such, they demonstrate the prac-
tical importance of the underlying issues addressed by
For developing countries, international financial insti-
the theory of regulatory governance as set out above.
tutions such as the ADB and the World Bank can also
help support private investment by underwriting guaran-
tees to the private investors arising from the regulatory
4. Regulatory governance and its implications for
conditions in the concession contract. These can, to some
institutional design
degree, help alleviate the sovereign risks from regulatory
or contract enforcement problems, but they cannot elim-
The classic article on this topic is Levy and Spiller
inate such risks.
(1994). The first objective of that paper (and their sub-
Of course, the role of any independent regulator in
sequent book) is to distinguish the issue of regulatory
relation to concession contracts needs to be carefully
governance (the framework for regulation) from that of
defined. For example, it must be established whether the
regulatory content (the methods of price, quality, etc.
regulator has any authority to negotiate or agree to
regulation used). The second objective is to discuss the
amendments to concession contracts. More usually,
key issues within regulatory governance that promote or
responsibility for amending contracts remains with the
discourage private investment in utilities. The other main
government (i.e. the body which negotiated the contract
objective is to identify the ways in which different coun-
in the first place).
tries address these issues as well the systematic reasons
In practice, the performance of concession contracts
for how and why they adopt different solutions.
in supporting private investment in infrastructure pro-
Levy and Spiller emphasise the role of the following
jects and utilities record is variable. Among the projects
aspects when appraising whether countries’ regulatory
generally reckoned to have been successful are the IPPs
frameworks provide an effective institutional design:
(independent power projects) in various Asian econom-
ies, including Indonesia, Malaysia, Pakistan and Thai- 1. the degree of independence of the judiciary;
land. It has been argued that the investors (including 2. the long-term credibility of legislation and the ease
lenders) have been able to protect themselves against with which primary laws can be enacted;
regulatory risks by the use of a structured series of con- 3. the scope for flexibility without arbitrariness in the
tracts, including extensive Implementation Agreements. regulatory process; and
However, others have argued that the degree of such pro- 4. the level of administrative competence.
tection against sovereign risk afforded by these contracts
A major element of the Levy and Spiller paper is the
may, in practice, be relatively limited (see Rowey,
risks from and the need to avoid having a regulator who
1997).
is too independent and has too much autonomy. Indeed,
The sceptics seem to have been proved right. The
they define regulatory governance as:
1997–98 Asian financial crisis has clearly demonstrated
the vulnerability of concession contracts where the out-
the mechanisms that societies use to constrain regulat-
put price (and sometimes the input price) are denomi-
ory discretion and to resolve conflicts that arise in
nated in foreign currency and there is a major exchange
relation to these constraints (Levy and Spiller, 1994,
rate shock. It is quite clear that the original (and large)
p. 205).
IPP contracts in Indonesia and Pakistan have become
unsustainable at the new exchange rates. In spite of the
In their subsequent exposition, Levy and Spiller
sophisticated contract structure, IFI and sovereign
emphasise that these mechanisms must achieve certain
guarantees, they will either be substantially renegotiated
objectives (including constraining the regulator from
or collapse.12
arbitrary behaviour), but that the design of such mech-
anisms must take good account of the constitutional,
11
See Cave and Stern (1998). Note, though, that there are also sub- legal and political characteristics of the country. Hence,
stantial monitoring and enforcement problems with them and one should expect different regulatory structures and
recessions come to all countries. Thailand and China are good instruments to be used in different countries.
examples of rapidly growing economies where a recession or even a
significant growth slowdown has caused problems for ambitious con- In their perception of the problem, each country must
cession contracts. try to devise regulatory mechanisms that correspond to
12
To follow the emerging saga, see FT Power in Asia, 1998. its “institutional endowment”. In this, they build on the
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
analysis of Douglass North, most notably in North
(1990). North characterises the institutional endowment
of any country in terms of five key attributes:
1. The country’s legislative and executive institutions.
This includes:
쐌 the mechanisms by which legislators and members of
the executive government are chosen;
쐌 the mechanics by which laws and regulations are
made;
쐌 the mechanisms for implementing laws and regu-
lations; and
쐌 the relationship between the executive and legislative
arms of government.
2. The country’s judicial institutions. This includes:
쐌 the mechanisms for appointing judges;
쐌 the mechanisms for determining the internal structure
of the judiciary;
쐌 the mechanisms available for impartially resolving
disputes (a) between conflicting private parties and (b)
between private parties and the state.
3. The country’s customs and informal, broadly
accepted norms of behaviour as generally understood
to constrain the behaviour and actions of individuals
and institutions.
4. The character of contending social interests within the
society. These include:
쐌 the balance of contending forces and their relative
power; and
쐌 the role and importance of ideology.
5. The administrative capabilities of the nation and its
institutions.
In their paper, Levy and Spiller place most emphasis on
the first two of these attributes. Thus, they discuss in
some detail the position in federal or unitary states, the
separation of powers, whether or not government is by
coalition, and whether or not there is a system of admin-
istrative law. They use this framework to analyse the
reasons for the relative effectiveness of regulatory insti-
tutions, primarily for telecommunications, in different
countries at different times.
4.1. Regulatory governance: formal and informal
accountability
One feature of the Levy and Spiller paper is that the
starting point of the analysis is that one should expect
different regulatory mechanisms to evolve in different
countries according to their institutional endowment.
Nevertheless, the focus of their empirical analysis is
entirely on countries with independent decision-making
regulators and the countries they examine are judged
primarily on whether or not they can effectively sustain
41
a regulatory system of the type developed in the USA.
Levy and Spiller do not address the issue of whether
there are feasible and credible institutional alternative
ways of devising and enforcing the regulatory contract
than that of the classic independent regulator.
In this context, it is important to remember that an
independent regulator is a means to an end. It is not an
end in itself.
The end in question is an institutional structure that
provides a framework in which (a) all consumers can
have access to utility services of acceptable quality at
lowest minimum cost; and (b) private (and state) inves-
tors can expect to earn a reasonable real rate of return
on their assets. It is quite possible that alternatives may
be devised that can achieve these ends for utilities that
do not require an independent regulator or would operate
more effectively with an advisory rather than a decision
making regulator.
It is certainly both possible and likely that an advisory
and/or semi-independent regulator with obligations to
publish and justify decisions may be more successful
than a decision-making regulator in countries where the
separation of powers is absent or limited. The alternative
may be a supposedly “independent” regulator who is
either effectively a creature of the government or can be
dismissed by the government at any time. Such a trade-
off is clearly present in many countries, including sev-
eral developing Asian economies.
This line of argument was set out in Stern (1997).13
In that paper, it is argued that “effective utility regulatory
institutions are ones that provide transparency and pre-
dictability”. In their analysis, Levy and Spiller, given
their focus on institutional design, emphasise issues of
formal accountability, e.g. in the design of legal frame-
works and the formal structures of legal systems. Con-
versely, Stern focuses on regulatory processes and prac-
tices. He, therefore, pays more attention to the
importance of issues of informal accountability—points
3 and 4 from North’s list set out above.
One way of distinguishing issues of formal account-
ability from those of informal accountability is to make
the distinction between matters of institutional design
and of regulatory processes. Another, and perhaps more
helpful, is to distinguish between the formal attributes
of the framework—as written in the letter of the law—
and the practical application of the framework and how
it is interpreted—the spirit of the law and how well it
is kept.
The key attributes of informal accountability are
specified as the degree to which the regulatory process:
쐌 encourages debate and open discussion;
쐌 involves all relevant parties;
13
See also Stern (1994) for an earlier discussion centred on utility
reform in the countries of Central and Eastern Europe.
42 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50

쐌 leads to justification by the regulator of decisions and 4.2. An appraisal framework for regulatory systems
methodologies; and
쐌 generally leads to a clear understanding by all parti- Based on the considerations set out in previous sec-
cipants of the “rules of the game” (see Stern, 1997, tions, we have identified six interrelated aspects of regu-
pp. 70–71). latory frameworks which characterise the main govern-
ance elements of economic regulation. These six aspects
Clearly, the formal aspects of regulatory account-
were used in the survey of regulatory practice for infra-
ability represent a crucial underpinning, the informal
structure industries in developing Asian countries that
ones are, however, just as important for the long-run suc-
NERA recently carried out for the Asian Development
cess of any regulatory framework. The sustained effec-
Bank (ADB). The ADB has since published the report
tiveness of regulatory systems depends on their con-
under the title “Governance and Regulatory Regimes for
tinued acceptability to governments, producers,
Private Sector Infrastructure Development”.
consumers—and the populace. Whatever legal safegu-
We use three aspects that relate primarily to insti-
ards may be put in place, unless they remain acceptable
tutional design (the formal aspects of regulation).
they will be changed. An independent regulatory agency
These are:
(or regulator) that does not command continued
acceptability will be replaced. Governments have a thou- 쐌 Clarity of Roles and Objectives;
sand and one ways of undermining a supposedly “inde- 쐌 Autonomy; and
pendent” regulator, whatever the underlying legal frame- 쐌 Accountability.
work.14
We also include three that relate primarily to regulatory
It is for these reasons that the thrust of Stern (1997)
processes and practices (informal accountability).
is to emphasise:
These are:
1. transparency;
쐌 Participation;
2. predictability; and
쐌 Transparency; and
3. a reputation for making fair and justifiable decisions
쐌 Predictability.15
and recommendations.
In broad terms, these features of the regulatory frame-
An accepted and well-established, decision-making inde-
work describe both the likely degree of political indepen-
pendent regulatory agency may well be the optimal sol-
dence and the processes which might increase the likeli-
ution in a country (a) with an institutional endowment
hood of the regulatory framework being acceptable to
that can support it; and (b) where it is acceptable to
firms, consumers and governments in the medium to
governments and the other key players. But, in many
long term. Importantly, they also cover the mechanisms
countries, including several developing Asian countries,
available to firms or governments if they are unhappy
these conditions are not met. The question is what to do
with the way in which regulation is being carried out.
then. This is a political economy problem of the “second
These elements also form the basis for the question-
(or third) best”.
naire (reproduced as Appendix A in this paper). The
Stern (1997) emphasises the need to concentrate on
questionnaire provides the basis for the appraisal of the
finding a regulatory system that is transparent and pre-
regulation of the Asian infrastructure industries summar-
dictable, but to use ingenuity in finding an appropriate
ised in the next section. It can be readily seen that the
legal form and not necessarily to be wedded to the US–
items included in the questionnaire are closely derived
UK model of an independent regulator operating under
from the theory of regulatory governance discussed in
a specific primary law. Such arrangements may be
previous sections.
second (or third) best, but they are no worse for that
One point to note is that our list of chosen criteria
if the first-best is unattainable. Not least, there is the
does not explicitly include reputation. This may seem
possibility—and potential advantages—of using such
surprising given the previous discussion. However, regu-
alternatives as an interim step to the development of a
latory reputation is covered in the questions we ask
full-blown independent regulator (see Stern, 1997, pp.
under the Predictability of regulation and, to a lesser
73–74).
extent, under its Transparency.

14
An anonymous referee has suggested that, if this argument were
accepted, the case for concession contracts (or other forms of explicit
regulatory contracts) as against conventional regulation with an inde-
pendent regulatory agency would be strengthened. Given the difficult-
ies over writing and enforcing contracts to cover all circumstances for
long periods in advance, we remain unpersuaded that the suggested
alternative route offers a credible let alone a superior alternative.
15
These six criteria include the four “key dimensions” of govern-
ance identified by the Asian Development Bank for all governmental
institutions, namely accountability, participation, predictability and
transparency; see ADB (1995). To these, we have added two critical
issues for effective regulation—clarity and autonomy.
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50 43

4.3. Appraisal criteria meaningful, in the sense that participants must have
a genuine chance of influencing decisions before they
The main reasons for examining each of these aspects are made (rather than being invited to state their views
of economic regulation are as follows: on a decision which has already been made).
쐌 Accountability18 requires that regulators’ decisions
쐌 Clarity of Roles and Objectives, particularly between
can be challenged in an effective way, if, for example,
Ministers and regulators, should help to make regu-
certain decisions are thought to be unfair or incom-
lation more effective by removing any possible con-
petent. If such appeals mechanisms exist, this will
fusion about which functions are carried out by regu-
reduce the risk of firms being treated unfairly (or ran-
lators, and which are carried out by Ministers (or other
domly, as a result of incompetence). Accountability
bodies, such as environmental agencies). Both
to customers (for example, if price limits seem too
accountability and predictability will be significantly
generous to the firm) is more difficult, but consumer
enhanced if regulators’ objectives are clearly stated,
groups and media comment may play a part. The
enabling them to be challenged if they depart from
regulator should also be accountable, for example
these objectives.16 A key issue under this heading is
through the legal system, for any failure on his part
the separation of regulation both from (a) policy-mak-
to fulfil his statutory obligations. Accountability to the
ing and (b) the commercial management of the com-
legislature (e.g. via the submission and discussion of
panies.
an annual report) can also be important in this context.
쐌 Autonomy from political intervention (which will be
쐌 Transparency is important in its own right, since a
easier to achieve if there is a clear statement of regu-
requirement on regulators to explain their decisions
lators’ objectives) will help to ensure that regulators
and processes should reduce the likelihood of
are free to carry out their functions in the way they
unfairness or incompetence. In addition, transparency
consider best satisfies their stated objectives, and their
is crucial for ensuring effective accountability, since
performance should be judged solely on this basis.
regulated firms and others will have a better under-
Autonomy will be promoted if regulatory bodies have
standing of regulators’ reasons for making certain
secure sources of funding, and if senior officers are
decisions, and will therefore be more confident in
protected from unfair dismissal by politicians and do
their ability to challenge some or all of those reasons.
not themselves stand to benefit from the political pro-
For similar reasons, transparency will help to secure
cess. Autonomy, and consequently the reduced likeli-
more effective participation, since firms (and
hood of regulatory decisions being politically mot-
consumers) will have a better understanding of the
ivated, should certainly enhance the predictability of
main factors which are likely to influence the regu-
regulated industries, as well as promoting account-
lator’s decisions (as well as his overall approach). It
ability and transparency (as regulators alone will be
is also important for predictability, since transparency
answerable for their decisions). Autonomy is most
implies that changes in regulators’ approaches to key
secure with an independent regulator operating under
decisions will be easier to detect.
a primary law which, among other things, (a) sets out
쐌 Predictability is clearly essential where firms are
key powers and duties, and (b) establishes its finan-
undertaking investment which needs to be recouped
cial security.
over a number of years. It means that firms can be
쐌 Participation, which occurs when relevant parties
reasonably confident that the “rules of the game” will
(including regulated firms, consumers and other
not suddenly change, either because of a change in
industry participants) contribute effectively to the
the overall legal and regulatory framework, or because
regulatory process, should improve the quality of
of a change in the way that regulators behave within
regulatory decisions and increase the likelihood of the
this framework. However, the attribute of pre-
regulator receiving both support and co-operation
dictability should also include the ability to achieve
from firms, consumers and others. Participation may
evolutionary change in regulatory methods and prac-
take many forms, including formal consultation exer-
tices to meet changes in circumstances in an orderly
cises, formal or informal hearings, and surveys of cus-
and consistent way.
tomer views and priorities.17 Participation should be
As noted above, the achievement of all of these
16
elements may be an unrealistic goal in some countries.
It requires sufficient accountability and transparency to ensure that
deviations from the stated objectives of regulation are detected and
remedied.
17 18
We do not include efforts to exert informal influence, for example Note that the notion of accountability discussed here is of formal,
through personal contacts or lobbying, in our definition of partici- legal accountability and excludes aspects of informal accountability
pation. This is a feature of many countries, even where best regulatory discussed in Section 4.1. Various aspects of informal accountability
practice is followed, but it is rarely beneficial and more often detrimen- are covered under the criteria of Participation, Transparency and Pre-
tal to good regulation. dictability.
44 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
It is essential that the regulatory framework remains
acceptable to firms, consumers and governments. Where
Autonomy (and the associated elements of Account-
ability and Clarity of Roles and Objectives) is not
realistically achievable, at least in the short to medium
term, the emphasis should be on achieving a regulatory
framework which features elements of Participation,
Transparency and Predictability.
The other important element, of course, which will
determine the acceptability of the regulatory framework
to firms, consumers and governments, is the quality of
regulatory decisions. A fair but incompetent regulator is
not necessarily better (and may be a lot worse) than a
biased but competent one.
Effective participation in the regulatory process may
help the regulator to make better decisions, while trans-
parency and accountability will increase the pressure on
him to do so. An autonomous regulatory body, which
has sufficient funding available to attract high quality
staff, may also make this more likely. But much will
still depend on the quality of the senior staff of the regu-
latory body, and the way in which they carry out their
functions.
5. Appraisal of regulatory governance in the
infrastructure industries of developing Asian
economies
On the basis of the arguments discussed in previous
sections, NERA drew up a questionnaire which provided
the basis for a set of qualitative, case-study appraisals of
the governance structure for 12 infrastructure industries
across six developing Asian economies. The industries
and countries are listed in Table 1. For India, our review
of electricity covers the recent major regulatory reforms
in the state of Orissa (an eastern Indian state, a few hun-
dred miles south of Calcutta) as well as the position
regarding Federal level regulation via the Indian CEA
(Central Electricity Authority).
The full results of the appraisal are set out in the
NERA (1998) report “Governance and Regulatory
Regimes for Private Sector Infrastructure Development”,
published by (and readily obtainable from) the Asian
Table 1
Countries and sectors surveyed
Electricity Gas
Bangladesh X
India X X
Indonesia X X
Malaysia
Pakistan X
Philippines X X
Note: X denotes country/sector selected for the survey.
Development Bank. In this paper, we summarise the
main findings and discuss some implications for regulat-
ory governance, both in developing economies and in
countries like the UK.
The sectors and countries were deliberately chosen by
NERA and the ADB to cover the observed range of out-
comes on:
쐌 the degree to which economic regulation has been
established as a separate activity;
쐌 the degree of clarity and transparency in regulatory
structures;
쐌 the degree to which private capital has been involved
in these industries in the different countries.
쐌 or each sector, a survey was carried out (a) of their
current regulatory governance arrangements; and (b)
of any officially proposed or approved changes in
regulatory arrangements. The survey was carried out
on a common basis for all sectors, using the question-
naire given in Appendix A.
NERA had previously conducted regulatory studies in
the majority of these countries and sectors and, in those
cases, the questionnaires were completed by NERA
economists who had worked in the sectors and countries
concerned. In the other cases, local specialist advisers
were commissioned to complete the questionnaire, work-
ing with NERA economists. The detailed results for each
sector are contained in a set of annexes at the back of
the published report (NERA, 1998, Annexes 2–13).
5.1. The criteria and rankings used in the regulatory
appraisal
The regulatory framework is scored for each of the
six indicators discussed above for each sector on a quali-
tative ranking from A to E. The rankings are intended
to indicate how firm a basis for supporting private
investment is provided by the regulatory framework for
each sector.
For each indicator, best international practice in terms
of the definition above yields a ranking of E. A ranking
of A is given to results for the indicator that imply a
highly unfavourable and/or uncertain regulatory basis for
private investment. Rankings of B, C and D were given
Telecoms Transport Water
X
X X X
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
for progressively more satisfactory regulatory frame-
works.19
Clearly, much hinges on the definition of “best inter-
national practice”. Inevitably, our view of best practice
is heavily influenced by experience from OECD coun-
tries. It is unclear how far this can be directly translated
into best practice for developing countries in Asia,
although there is no evidence for any alternative set of
attributes for Asian best practice.
We set out below, for each of the six criteria, our
definitions of our rankings of E (best international
practice) and A (regulatory arrangements that are wholly
unfavourable to private sector investment).
1. Clarity of Roles and Objectives
Rank E (best practice). The regulatory function is
well-articulated, well-enshrined in primary legis-
lation, and clearly separated in practice from the pol-
icy and commercial functions.
Rank A (wholly unfavourable to private investment).
No specification of any separate regulatory functions
or responsibilities is apparent; there is no primary
law covering regulatory issues, and no effective dis-
tinction between policy and regulation.
2. Autonomy
Rank E (best practice). There is a separate regulator
with arrangements for appointment and financing
which appear to guarantee autonomy of action.
Rank A (wholly unfavourable to private investment).
There is no separately identifiable regulatory func-
tion, or it is performed mainly or solely by a senior
political official.
3. Participation
Rank E (best practice). A comprehensive process of
formal consultation (including public hearings and
publication of and comment on consultation
responses) is followed before decisions are made.
Rank A (wholly unfavourable to private investment).
Little or no formal consultation takes place.
4. Accountability
Rank E (best practice). There is full accountability
in terms of appeals, including a specific legal right
of redress. The accountability of the regulator to
Courts or parliament for fulfilling general legal
duties is appropriate without being excessive.
Rank A (wholly unfavourable to private investment).
No appeal or redress is available and there is no for-
mal mechanism of accountability.
19
See NERA (1998) for a full discussion of how the information
was collected and the details of the ranking classifications for each
indicator.
45
5. Transparency
Rank E (best practice). All regulatory documents are
available to the public, except where specifically
classified as confidential and the regulator publishes
major decisions as well as the reasoning behind
major decisions;
Rank A (wholly unfavourable to private investment).
There is no significant public information available
regarding regulatory instruments or decisions.
6. Predictability
Rank E (best practice). Regulatory powers and duties
cannot be changed without changes in primary law;
key regulatory instruments or documents cannot be
changed without undergoing appropriate processes;
and there is a clear policy and coherent approach
behind all decisions.
Rank A (wholly unfavourable to private investment).
Changes to all aspects of regulation can be under-
taken relatively easily, and little or no consistency
has been observed in regulatory practice.
5.2. Results of the appraisal
The survey was carried out in January 1998. The main
results are summarised in Table 2. For the sample as a
whole, the rankings show better performance on some
attributes than others. It is not surprising that no sector
scores better than a C for Predictability, since the best
laws (in terms of formal properties) are the most recent
and the new agencies do not yet have a track record.
Similarly, it is not surprising (if disappointing) that only
two sectors have a ranking better than a C on Trans-
parency—or on Accountability or Participation.20 More
surprising, and perhaps more worrying, is that only one
sector (Orissan electricity) has a ranking better than a C
on Clarity of Roles and Objectives, the most fundamen-
tal attribute of the formal regulatory framework.
In general, with the clear exception of India, the
results are relatively uniform by country across the
industries. From other information available to us, we
suspect that this would apply to the other infrastructure
industries in these countries—and to other countries,
both in Asia and elsewhere.
The table follows (Table 2) shows that, in most cases,
individual sectors show a reasonable degree of consist-
ency across the different criteria. However, in the case
of one or two sectors there is a significant variation in
categories across the criteria. For example, Orissa elec-
tricity varies from category B to category E, although
this largely reflects the lack of a track record. The review
of the sectors therefore suggests that, on the basis of our
20
Indian Telecoms and electricity in Orissa.
46 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50

Table 2
Overall summary of findings

Country and sector Categorisation by criteria

Clarity Autonomy Participation Accountability Transparency Predictability

Bangladesh
Electricity B B A B A A
India
Electricity, Federal B C A B C A
Electricity, Orissa D E E D E B
Natural gas A A A A C A
Telecoms C D E D E C
Indonesia
Natural gas A A A A A A
Transport A A A A A A
Malaysia
Telecoms C C C B A A
Transport C C B B A B
Water C B B B A B
Pakistan
Electricity Ca Da Ca Ca Ca Ba
Philippines
Electricity C C C B B C
Water C C C C C B

a
These markings depend on the effective implementation of the new law on electricity.

chosen assessment framework, they can be divided into survey have shown mixed experience.21 The new
four distinct groups. regulatory agency (which is very largely concerned
with mobile rather than fixed-line services) is having
1. Orissa electricity and India telecoms have many simi-
to fight hard to maintain its position and, although it
lar properties, and they represent the sectors closest
has won some disputes taken to the High Court, it
to best practice among those surveyed. Both have
has lost others.
been the subject of new regulatory legislation in the
2. Pakistan electricity, Philippines electricity and Philip-
last 5 years, so that they have benefited from recent
pines water have certain common characteristics, and
experience elsewhere and observation of best prac-
in particular all have regulatory agencies with a
tice. Both sectors have also undergone structural lib-
reasonable degree of autonomy. These sectors have
eralisation, and it appears that the recognition of the
basic frameworks which could be capable of moving
need for improved regulation has gone hand in hand
forward and delivering quite good standards of regu-
with such structural reform. At the same time, for
lation. In some cases the sectors are showing signs
both these cases there are clear indications of a shift
of reform and the increased introduction of private
towards private sector capital becoming an important
capital, though so far this has been comparatively
part of the future development of the sector, necessit-
limited. Pakistan electricity is something of a special
ating better regulation. Although not yet fully meeting
case, as its ranking position is heavily dependent on
best practice, both cases have autonomous regulatory
effective implementation of the new law, which has
agencies. These two cases are significantly ahead of
not happened. For the Philippines, an important
their nearest rivals in regulatory governance terms.
obstacle to improved regulatory governance would
However, a qualification which applies to both these
seem to be the negative impact on the regulatory
cases is that they have yet to establish a track record.
framework arising from constitutional and political
It has been suggested to us that these rankings may
factors; major changes may be necessary to overcome
primarily reflect the fact that India and Pakistan have
these problems.
the ability and experience to prepare and enact good
As discussed above, developments since January
laws but are less able to carry out effective regulation
1998, have clearly demonstrated the fragility of the
on a sustained basis. Hence, our survey results may
new regulatory framework for electricity in Pakistan,
be suggesting an over-optimistic picture. Against this,
one can argue that good regulation requires a strong
formal legal framework and is much harder (some
would say impossible) without it. Nevertheless, 21
See reports in Financial Times Telecommunications Newsletters
developments in Indian telecoms since the date of the and other trade press articles.
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
where major problems have erupted and have yet to
be resolved.
3. An important factor common to Indian (Federal) elec-
tricity, and Malaysia telecoms, transport and water,
is that though regulatory agencies have been estab-
lished, they are all closely associated with govern-
ment, and this raises concerns with regard to partici-
pation, transparency, and predictability. All the
Malaysian sectors surveyed benefited from major new
regulatory legislation in the late 1980s or early 1990s,
but though these provisions may have been seen as
desirable improvements at that time, they can now be
seen as falling significantly short of best practice. We
discuss below how this might change in the light of
the Asian financial crisis.
4. In the cases of Bangladesh electricity, Indian natural
gas, and Indonesia gas and transport, not only has
there been no regulatory reform, but they also display
significant shortcomings in virtually all criteria. It is
notable that these sectors have also not yet experi-
enced structural reform or privatisation. They either
have very old legislation applying to regulation, or
no substantive regulatory legislation at all.
In Bangladesh, there were signs of movement
before the Asian financial crisis broke out. Indonesia
is an example of a country whose response to the
Asian financial crisis has been to pursue more effec-
tive regulation. This is true for electricity (and for
natural gas). It remains to be seen how effective these
reform attempts will be.
Our results are inevitable, since there was little if any
opportunity to assess the actual performance of the
recently instituted regulatory frameworks in India and
Pakistan. This is reflected in moderately low rankings
for Predictability, but otherwise we have given the new
regulatory systems the benefit of the doubt. The risks in
taking such a view are illustrated by our assessment of
the utility regulation frameworks in the Philippines’
regulatory systems. These (particularly for electricity)
are not as sound as the new Indian and Pakistani frame-
works, but, at least on paper, they are not seriously
inferior. However, there is over 30 years of experience
with the Philippines system which appears to have seri-
ous defects—primarily revealed in the markings for Par-
ticipation and Transparency (and also Clarity of Roles).
These essentially reflect weaknesses in how the frame-
work operates in practice rather than weaknesses in the
formal structure.22 There can be no such evidence yet
for the new Pakistan and Indian frameworks. Hence, any
assessment of them must be provisional.
We noted above that both the regulatory agencies for
Indian telecoms and Pakistan electricity have, during
1998, had problems in establishing and maintaining their
22
See the sector annexes in NERA (1998).
47
position and autonomy over key regulatory decisions.
These may just be initial teething problems or they may
reflect more fundamental difficulties. The former seems
rather less likely in the case of Pakistan electricity. In
the longer run, the test will be whether or not these new
frameworks establish a reputation for credibility and,
more importantly, whether they generate more private
investment into the industries and/or with a lower cost
of capital.
The impact on fixed investment is the test rightly
applied by Levy and Spiller in appraising the perform-
ance of regulatory systems for telecoms in different
countries. However, this requires some years of experi-
ence with the new regulatory system to elapse to
accumulate the necessary data. It also requires the separ-
ation of the impact of regulation from all of the other
relevant influences on private investment in these indus-
tries (demand, supply, confidence, etc.). This is no easy
task. In the meantime, we would argue that the results
from our assessment framework provide good pro-
visional indicators as well as pointers for a longer run
and/or more formal statistical analysis.
In this context, we note the recent paper by Bergara et
al. (1998), which reports on the findings of some initial
regression results for the effects of good regulatory
governance on investment (strictly speaking, generation
capacity) in electricity for samples of 38 and 87 coun-
tries. Their analysis indicates that well-defined and cred-
ible political institutions appear to be significant
explanatory variables for generation capacity, after con-
trolling for income levels, the degree of industrialisation
and of urbanisation. More specifically, within this,
judicial independence seems to be particularly important
(see Bergara et al., 1998, pp. 24–26).
One aspect not covered in our framework is the inter-
action between: (a) the design of regulatory frameworks
and (b) their administration. This raises a variety of
issues and would further complicate the analysis. How-
ever, a particular issue relevant to an economic evalu-
ation of such systems (and also to governments in choos-
ing regulatory frameworks) is the volume of resources
and speed of decision making in different regulatory
models.
One example of this is that supporters of the UK sys-
tem like to emphasise the fact that the costs and volume
of high level professional input are much lower than in
a more open rule and court-based system as in the US.
But, there are also costs associated with this approach
and it is very noticeable how the UK system has in
recent years consistently evolved to increase the degree
of formality. Such trade-offs can be (and often are) cru-
cial in countries like the Asian developing economies or
the countries of Central and Eastern Europe. There are
other related trade-offs, e.g. in the complexity of
methods of price regulation where such countries may
be better advised to follow the Levy and Spiller rec-
48 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
ommendation of simple and robust regulatory content
rules rather than more information-intensive and com-
plex OECD best practice procedures.
The results of our assessment can also be used to
appraise the direction of movement towards best practice
in our Asian sample as well as any indications of conver-
gence, e.g. towards best practice OECD solutions. The
key results on this are:
1. Direction of movement
쐌 a number of countries have made substantial changes
to their regulatory frameworks but none has yet had
more than one set of regulatory changes;
쐌 the changes, particularly to best practice regulatory
frameworks, are strongly associated with plans for
restructuring and privatisation;
쐌 later changes (in India and Pakistan) have demon-
strated moves towards more radical regulatory reform,
at least on paper, but there are not enough cases to
demonstrate a causal relationship;
쐌 looking ahead, the proposed speed of change again
differs widely between sectors and countries, but all
proposed changes are in the direction of OECD best
practice.
2. Convergence. There is no clear evidence of conver-
gence to any common solution let alone to OECD
“best-practice” either on the formal aspects of regu-
latory regimes or, as yet, on regulatory practice.
However, we recognise that, at least in part, this
reflects uncertainties about how far OECD best prac-
tice can be directly translated into best practice for
Asian developing economies. The two specific con-
clusions we draw are:
쐌 we cannot necessarily associate more recent reform
with formal regulatory procedures that are closer to
“best-practice”; and
쐌 looking forward (e.g. over the next 3–5 years), there
is no clear sign of a convergence towards current best
practice for the formal institutional aspects of regulat-
ory governance.
Hence, on convergence, we conclude that it remains
to be demonstrated that “best practice” regulatory frame-
works can and do work effectively in Asian developing
market countries.
Effective systems for economic regulation in these
countries will need to have greater clarity, transparency
and accountability than most current systems if they are
successfully to support private (and foreign) investment
at reasonable cost. It also remains unclear whether Asian
DMCs will (or should) adopt the institutional framework
associated with current international “best practice” or
whether they will produce new variants on regulatory
practice, but with different types of institution.
5.3. Implications for private investment
The judgements on infrastructure regulation set out
above represent our view on trends, past and future, as
they appeared in early 1998. However, it is clear that
this picture could change significantly and quite quickly.
Much of the comment on the Asian financial crisis in
1997–98 has drawn attention to regulatory failings
affecting the financial sector, particularly the lack of
transparency (see, for example, Krugman (1998a, b) and
various IMF and World Bank statements).23 Most
recently, Stiglitz (1998) has argued strongly that strong
and robust economic performance depends crucially on
effective regulation for the financial sector and for all
sectors where economic theory indicates that private sec-
tor markets need the support of effective regulatory insti-
tutions to operate efficiently and effectively. It remains
to be seen whether or not these arguments will lead to
a reappraisal within Asian developing countries as to the
advantages and disadvantages of more independent and
transparent regulatory frameworks for infrastructure
industries. Some countries in our survey (Indonesia and,
also perhaps, the Philippines) and others not included
here (e.g. Thailand) already show some signs of drawing
such lessons.
An optimistic observer would probably look at the
results from our survey and point to the fact that all of
the past and proposed changes in regulatory governance
for infrastructure were in the direction of best practice.
The trend, particularly in terms of formal regulatory
arrangements, is clearly towards greater clarity, account-
ability and autonomy. A pessimistic observer could,
though, point to the absence (so far at least) of any well-
established independent regulatory agency with a repu-
tation for fair and effective regulation as well as to the
weaknesses regarding transparency and the other aspects
of informal accountability.
Much will depend on how the recently established
independent regulatory agencies operate in practice in
the years ahead. In other countries, including Malaysia
and perhaps China, the outcome will depend on whether
the proponents of market-openness are able to maintain
and extend their position against the consolidators who
would prefer to batten down the hatches.
Looking ahead, the performance of the recent and pro-
spective regulators will be a key indicator of effective
regulatory governance, particularly for their impact on
the availability and cost of private investment. They may
well be as effective in practice as they promise to be on
paper, with a reputation for sound, fair and predictable
regulation. However, we have previously pointed to the
cautionary example of the Philippines. The Philippines
23
See also “Frozen miracle”, Economist Survey of East Asian Econ-
omies, 7 March 1998 and references therein.
 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
has long had a US-type regulatory system with many
checks and balances, but, in practice, it works very dif-
ferently from that in the US and, as of early 1998, did
not provide a predictable or effective system of regulat-
ory governance.24
In electricity, the Philippines authorities found it
necessary to give sovereign guarantees and other con-
siderable protection to investors in the early IPP
(Independent Power Producer) contracts negotiated in
the 1990s. This should not have been necessary if the
regulatory governance procedures had been working
well and were regarded by potential investors as provid-
ing effective support for private investment in infrastruc-
ture. Similarly, more recent developments in Asian
developing countries in 1997–98 (particularly in
electricity) have shown the need but also the limitations
of regulation for generating private investment in diffi-
cult times without contractual commitments from
governments and frequently, from the international fin-
ancial agencies.
Effective regulation is most important for supporting
private investment in slow-growing economies. Up to
the onset of the Asian financial crisis in 1997, strong
growth in Indonesia and Malaysia lessened the need for
transparent, autonomous, accountable and effective regu-
lators to attract private investment into their infrastruc-
ture industries. In the absence of more transparent regu-
lation, it is likely that private (and foreign) investment
will only be attracted to them in coming years in any
quantity at considerable cost, if at all.
We have deliberately emphasised transparency in this
discussion for two reasons. Firstly, transparency is
essential for effective and predictable regulation. Our
survey suggests that good practice regarding trans-
parency is particularly limited in our sample. Secondly,
many analyses of the Asian financial crisis, including
those cited above, emphasise the major role of the lack
of transparency in financial markets and financial market
regulation in provoking the financial crisis. Transparency
is also likely to be associated with good political prac-
tice, including judicial independence. It also helps pro-
mote other aspects of good regulatory governance,
Accountability in particular, but also Participation and
Predictability.
We conclude that the results from our assessment
framework provide a useful basis for appraising and dis-
cussing the effectiveness of regulatory frameworks in
supporting private investment in infrastructure indus-
tries. We have demonstrated its applicability for
developing Asian economies and we look forward to
24
Our findings for Philippines electricity and water industries are
supported by the analysis of Philippines telecommunications by Esfah-
ani (1996).
49
seeing how it may be applied and developed in other
contexts.
Acknowledgements
We would like to acknowledge the contributions of
Dennis Colenutt and Phillipa Marks to the work reported
in this paper. We would also like to acknowledge the
contribution to and continued support for this work from
Hamid Sharif and Barry Metzger of the Asian Develop-
ment Bank and from the Regulation Initiative of the Lon-
don Business School. The paper has also been signifi-
cantly improved by the helpful comments of an
anonymous referee and by Richard Green’s editorial
contribution. The paper and the views expressed in it
are, however, solely the responsibility of the authors.
Appendix A
Survey questions
We have identified six core elements which will affect
the governance properties of regulatory frameworks:
1. Clarity of Roles and Objectives;
2. Autonomy;
3. Participation;
4. Accountability;
5. Transparency;
6. Predictability.
For each of these six elements we have constructed a
short series of questions, which are set out below.
Clarity of Roles and Objectives
쐌 Does the primary legislation set out a clear definition
of the regulator’s functions and duties?
쐌 If not, are these functions and duties formally set out
in legal instruments and/or other documents?
쐌 Is it clear where the regulator has an advisory role
(e.g. to the Minister) rather than a decision making
role?
쐌 Are there any functions carried out jointly, or any that
are ambiguous, between the regulator and those of the
relevant Minister(s)?
쐌 Does the legislation establish unambiguously which
entity is responsible for what regulatory functions?
쐌 Does the regulator have any responsibility for com-
mercial activities?
50 J. Stern, S. Holder / Utilities Policy 8 (1999) 33–50
Autonomy
쐌 What is the relationship between the regulatory body
and the government (e.g. a separate division of a Min-
istry, a body independent of any Ministries, a body
independent of government, etc.)?
쐌 How are members of the regulatory body appointed
and dismissed?
쐌 How is the regulatory body financed? Who has to
approve the funding?
쐌 In what cases does the regulator have only an advisory
role (rather than a decision making role)?
Participation
쐌 Does the regulator formally involve regulated firms,
other industry firms, consumers and others on:
—major decisions?
—the proposed approach to taking major decisions?
쐌 Are consultation responses made public (either in full
or in a summary of responses)?
쐌 Does the regulator comment publicly on points made
in consultation responses, and how (if at all) these
have affected the final decision?
쐌 Are there any other indications of whether or not con-
sultation responses influence the final decision?
쐌 What other ways are industry participants (including
firms and consumers) involved in regulatory decision
making and processes?
Accountability
쐌 Is there a formal mechanism for regulated firms (or
other parties) to challenge regulatory decisions?
쐌 If so, how does it work? And has it been used?
쐌 Is there also a legal right of redress?
쐌 Do firms or other parties comment (or even challenge)
decisions through informal channels (such as direct
representations to Ministers, or through the media)?
쐌 To whom is the regulatory body accountable
(government, parliament, courts)?
쐌 Does the regulator have to answer questions before
parliament?
쐌 Can the regulator be dismissed for failing to fulfil
his duties?
쐌 Is there under primary law a facility for judicial
review?
Transparency
쐌 Are major regulatory documents (e.g. licences) in the
public domain?
쐌 Does the regulator publish major decisions (or
advice)?
쐌 Does the regulator publish the reasoning behind
major decisions?
쐌 If decisions/reasons are published, is this voluntary or
compulsory (e.g. a legal requirement to justify
decisions)?
쐌 If decisions/reasons are not published, are any parti-
cipants (such as the firms themselves) told of the
reasons for major decisions?
Predictability
쐌 How easily can the regulator’s functions and duties
be changed and what is involved?
쐌 How easily can key regulatory documents (e.g.
licences, authorisations, franchise contracts, etc.) be
changed and what is involved?
쐌 To what extent are regulatory principles (e.g. on the
procedural approach to tariff reviews, the definition
of the rate base or the rate of return which a firm
should be allowed to earn) set out formally?
쐌 Have the regulator’s decisions demonstrated a consist-
ent approach?
쐌 Is there a published timetable of regulatory events
every year?
쐌 To what extent are regulatory arrangements in the sec-
tor part of a coherent approach (i.e. echoed in other
infrastructure sectors) and to what extent are they ad
hoc (i.e. different in institutional structure from other
infrastructure sectors in the country)?
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