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Infrastructure investment in network industries: The role of incentive regulation and regulatory independence

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  • Balazs Egert

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Abstract

This paper finds that coherent regulatory policies can boost investment in network industries of OECD economies. Rate-of-return regulation is generally thought to result in overinvestment, while incentive regulation is believed to entail underinvestment. Yet, previous empirical work has generally found that the introduction of incentive regulation has not systematically changed investment in network industries. According to the theoretical literature, regulatory uncertainty exposes both types of regimes to the danger of underinvestment. However, regulatory uncertainty is arguably higher under rate-of-return regulation because investment decisions (what can be included in the rate base) are usually evaluated in a discretionary manner, while firms operating under incentive regulation are less affected by this behaviour. In addition, incentive regulation encourages investment in cost-reducing technologies. Using Bayesian model averaging techniques, this paper shows that incentive regulation implemented jointly with an independent sector regulator (indicating lower regulatory uncertainty) has a strong positive impact on investment in network industries. In addition, lower barriers to entry are also found to encourage sectoral investment. These results support the importance of implementing policies in a coherent framework.

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Bibliographic Info

Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number wp956.

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Length: pages
Date of creation: 01 Apr 2009
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Handle: RePEc:wdi:papers:2009-956

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Keywords: network industries; regulation; incentive regulation; price cap; cost-plus regulation; rate-of-return regulation; regulatory independence; investment.;

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  1. Joskow, Paul L., 2006. "Competitive Electricity Markets and Investment in New Generating Capacity," Working paper 152, Regulation2point0.
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Cited by:
  1. Carlo Cambini & Laura Rondi, 2011. "Independence, Investment and Political Interference: Evidence from the European Union," RSCAS Working Papers 2011/42, European University Institute.
  2. Åsa Johansson & Yvan Guillemette & Fabrice Murtin & David Turner & Giuseppe Nicoletti & Christine de la Maisonneuve & Guillaume Bousquet & Francesca Spinelli, 2012. "Looking to 2060: Long-Term Global Growth Prospects: A Going for Growth Report," OECD Economic Policy Papers 3, OECD Publishing.
  3. Jacques Pelkmans & Lionel Kapff, 2010. "Interconnector Investment for a Well-functioning Internal Market. What EU regime of regulatory incentives?," Bruges European Economic Research Papers 18, European Economic Studies Department, College of Europe.
  4. Potrafke, Niklas, 2010. "Does government ideology influence deregulation of product markets? Empirical evidence from OECD countries," Munich Reprints in Economics 19284, University of Munich, Department of Economics.
  5. Bernardo Bortolotti & Carlo Cambini & Laura Rondi, 2011. "Regulatory Independence, Ownership and Firm Value: The Role of Political Institutions," RSCAS Working Papers 2011/43, European University Institute.
  6. Cambini, Carlo & Franzi, Donata, 2013. "Independent regulatory agencies and rules harmonization for the electricity sector and renewables in the Mediterranean region," Energy Policy, Elsevier, vol. 60(C), pages 179-191.
  7. Carlo Cambini & Laura Rondi, 2010. "Regulatory Independence and Political Interference: Evidence from EU Mixed-Ownership Utilities’ Investment and Debt," Working Papers 2010.69, Fondazione Eni Enrico Mattei.
  8. Cambini, Carlo & Spiegel, Yossi, 2011. "Investment and capital structure of partially private regulated firms," CEPR Discussion Papers 8508, C.E.P.R. Discussion Papers.
  9. Ingo Vogelsang, 2010. "Incentive Regulation, Investments and Technological Change," CESifo Working Paper Series 2964, CESifo Group Munich.

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