Economic Regulation: Its Rationale and Function 2 nd CUTS-CIRC International Conference on Reviewing the Global Experience with Economic Regulation New Delhi, India April 19, 2011 Ashley C. Brown Executive Director, Harvard Electricity Policy Group John F. Kennedy School of Government Harvard University Of Counsel, Dewey & LeBoeuf

Economic Regulation – Basic Purpose 1. Correct for Market Failures a. Monopoly i.Natural (Economies of Scope and Scale) 1.Regulatory Controls (pricing, quality, etc.) and Incentives for Efficiency ii.Non-Natural: Identifying and Rectifying 1.Enable Market Forces (e.g. Remove Barriers, Limit Power of Incumbents) 2

Economic Regulation – Basic Purpose 1. Correct for Market Failures (cont’d) b. Information and Transparency i.Asymmetrical Information (e.g. securities trading, disclosure, transparency cost) ii.Market Opaqueness (e.g. poor price signals, unclear rules) c. Financial Stability i.Reserve requirements for Banks and Insurers 3

Economic Regulation – Basic Purpose 2. Fill Gaps in What Markets Do Not Produce (Efficiency vs. Equity) Attainment of Articulated Public Policy Objectives Universal Service Consumer Protection Stewardship of The Commons (e.g. environmental) 4

Ten Key Principles for Regulatory Institutional Framework 1. Independence 2. Accountability 3. Transparency and Public Participation 4. Predictability 5. Clarity of Roles 6. Completeness and Clarity of Roles 7. Proportionality 8. Requisite Powers 9. Appropriate Institutional Characteristics 10. Integrity 5

Critical Standards for Effective Substantive Regulation Legal Framework Legal Powers Property and Contract Rights Clarity of Roles in Regulation and Policy Clarity and Comprehension of Regulatory Decisions Predictability and Flexibility Consumer Rights Proportionality Financing of Regulatory Agencies Regulatory Independence Regulatory Accountability Regulatory Processes and Transparency Public Participation Appellate Review of Regulatory Decisions Ethics 6

Caveat: Regulation and Industry Outcomes Regulatory decisions are only one determinant of industry outcomes Regulatory agencies are often by no means the most important determinant of sector outcomes. Sector outcomes may be more affected by: Poorly designed market structures (California, Brazil) Inconsistencies in Government policy and/or government unwillingness to allow the regulatory agency to carry out its functions External pressures (e.g. macroeconomic and exchange rate crisis) Good regulation does not always produce good outcomes for the regulated sector, but bad regulation will almost always contribute to bad outcomes. 7