London Business School and City University, London Regulatory Governance and Electricity Investment in Developing Countries Jon Stern London Business School and City University, London March 2006

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

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

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

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

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

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

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

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

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

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

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

Links to Supporting Papers Main Paper discussed: Cubbin, J.S and Stern J., (2004), “Regulatory Effectiveness: The Impact of Good Regulatory Governance On Electricity Industry Capacity And Efficiency In Developing Countries”   http://papers.ssrn.com/sol3/papers.cfm?abstract_id=695385 Final version World Bank Economic Review forthcoming, with (paid-for) online availability See also Stern, J. and Cubbin J.S. (2003), “Regulatory Effectiveness: The Impact of Regulation and Regulatory Governance Arrangements on Electricity Outcomes – A Review Paper” http://papers.ssrn.com/sol3/papers.cfm?abstract_id=695386