2 - The rent extraction–efficiency trade-off

Summary

Introduction

Following the pioneering application of incentive theory to regulation by Loeb and Magat (1979) and Baron and Myerson (1982), the 1980s witnessed the emergence of a new theory of regulation which emphasized the role of informational asymmetries between government, regulatory commissions, firms, and various interest groups. This work has been synthesized in particular in Laffont and Tirole (LT, Laffont and Tirole, 2000).

These theories have been developed at the same time as the large privatization–deregulation–liberalization movement was taking place in Europe, in the United States, and soon after in Latin America, and quite naturally focused on developed countries. Under the pressure of the International Monetary Fund (IMF) and the World Bank, this movement was imposed on LDCs in the 1990s with no attention paid to the specific circumstances of these countries.

In this chapter we recap in section 2.2 a canonical model of regulation built for developed countries. Then, in section 2.3 we examine the insights one can draw from this model in the light of the characteristics of LDCs. We use a unique data set of concession contracts in Latin America built by Guasch (2003) at the World Bank to test our theory. In section 2.4 we stress the weaknesses of this model for analyzing LDCs and make a list of the desirable extensions needed for a proper policy discussion of network industries in LDCs. Section 2.5 briefly concludes.

A simple model of regulation

Description

We consider a natural monopoly in charge of a public service such as water, electricity, telecommunications, or transportation.