RegulationandDevelopment InRegulationandDevelopmentJean-JacquesLaffontprovidesthefirsttheo- reticalanalysisofregulationofpublicservicesfordevelopingcountries.He showshowthedebatebetweenprice-capregulationandcost-of-servicereg- ulationisaffectedbythecharacteristicsoflessdevelopedcountries(LDCs) andoffersapositivetheoryofprivatizationthatstressestheroleofcorrup- tion.Hedevelopsanewtheoryofregulationwithlimitedenforcementcapa- bilitiesanddiscussesthedelicateissueofaccesspricinginviewofLDCs’ specificities.Inthefinalchapterheproposesatheoryofseparationofpowers whichrevealsoneofthemanyviciouscirclesofunderdevelopmentmade explicitbytheeconomicsofinformation.Basedonorganizationtheoryand history,andusingsimpleempiricaltestswhereverpossible,ProfessorLaf- fontoffersacomprehensiveevaluationofthedifferentwaystoorganizethe regulatoryinstitutions.AnauthoritativebookfromoneofEurope’sleading economists,itmakesasignificantcontributiontothefield. Jean-Jacques Laffont was Professor of Economics at the University of ToulouseandattheUniversityofSouthernCalifornia.Hepublishedexten- sivelyinpubliceconomics,incentivetheory,developmenteconomics,and theeconomicsofregulation.Hediedin2004. FedericoCaffe` Lectures ThisseriesofannuallectureswasinitiatedtohonourthememoryofFederico Caffe`.TheyarejointlysponsoredbytheDepartmentofPublicEconomicsat theUniversityofRome,whereCaffe`heldachairfrom1959to1987,andthe BankofItaly,whereheservedformanyyearsasanadviser.Thepublication ofthelectureswillprovideavehicleforleadingscholarsintheeconomics profession,andfortheinterestedgeneralreader,toreflectonthepressing economicandsocialissuesofthetimes. Regulation and Development Jean-Jacques Laffont PUBLISHED BY THE PRESS SYNDICATE OF THE UNIVERSITY OF CAMBRIDGE ThePittBuilding,TrumpingtonStreet,Cambridge,CB21RP,United Kingdom CAMBRIDGE UNIVERSITY PRESS TheEdinburghBuilding,Cambridge,CB22RU,UK 40West20thStreet,NewYork,NY10011–4211,USA 477WilliamstownRoad,PortMelbourne,VIC3207,Australia RuizdeAlarco´n13,28014Madrid,Spain DockHouse,TheWaterfront,CapeTown8001,SouthAfrica http://www.cambridge.org (cid:1)C Jean-JacquesLaffont2005 Thisbookisincopyright.Subjecttostatutoryexception andtotheprovisionsofrelevantcollectivelicensingagreements, noreproductionofanypartmaytakeplacewithout thewrittenpermissionofCambridgeUniversityPress. Firstpublished2005 PrintedintheUnitedKingdomattheUniversityPress,Cambridge TypefaceMelior10/13pt. SystemLATEX2ε [TB] AcataloguerecordforthisbookisavailablefromtheBritishLibrary LibraryofCongressCataloguinginPublicationdata Laffont,Jean-Jacques,1947–2004 Regulationanddevelopment/Jean-JacquesLaffont. p. cm.–(FedericoCaffe`lectures) Includesbibliographicalreferencesandindex. ISBN0-521-84018-X–ISBN0-521-54948-5(pbk.) 1.Municipalservices–Developingcountries. 2.Municipal services–Governmentpolicy–Developingcountries. I.Title. II.Series. HD4431.L342004363.6(cid:2)01–dc22 2003069754 ISBN052184018Xhardback ISBN0521549485paperback ThepublisherhasuseditsbestendeavourstoensurethattheURLsfor externalwebsitesreferredtointhisbookarecorrectandactiveatthetime ofgoingtopress.However,thepublisherhasnoresponsibilityforthe websitesandcanmakenoguaranteethatasitewillremainliveorthatthe contentisorwillremainappropriate. Contents Publisher’sacknowledgment pageix Foreword Fran¸coisBourguignon xi Y.HosseinFarzin xv Preface xvii Introduction xix 1 Overviewofregulatoryissues 1 1.1 Introduction 1 1.2 Structuralissues 4 1.3 Regulationofnaturalmonopolies 14 1.4 Promotingcompetitionbypricingaccess 28 1.5 Competitionpolicy 33 1.6 Universalservice 37 1.7 Conclusion 38 2 Therentextraction–efficiencytrade-off 40 2.1 Introduction 40 2.2 Asimplemodelofregulation 41 2.3 Optimalregulationandthecharacteristics ofdevelopingcountries 55 2.4 Therentextraction–efficiencytrade-offinpractice 59 2.5 Conclusion 61 3 Apositivetheoryofprivatization 64 3.1 Introduction 64 3.2 Literaturereview 66 3.3 Themodel 73 vi Contents 3.4 Privatization 80 3.5 Testingthetheory 85 4 Enforcement,regulation,anddevelopment 96 4.1 Introduction 96 4.2 Optimalregulation 100 4.3 Regulationandenforcement 106 4.4 Predictionsofthemodel 109 4.5 Conclusion 116 Appendix 116 5 Accesspricingrulesfordevelopingcountries 118 5.1 Introduction 118 5.2 Abouttheoptimalityofthemarketstructure 119 5.3 Structuralseparationandpricingofaccesstoan independentlyownedinfrastructure 121 5.4 One-wayaccesswithverticalintegration 127 5.5 Two-wayaccess 133 5.6 Conclusion 135 6 UniversalserviceobligationsinLDCs 137 6.1 Introduction 137 6.2 Thebasicsetting 140 6.3 Optimalregulationunderpricediscrimination 141 6.4 Optimalregulationunderuniformpricing 146 6.5 Universalservicepolicyundercollusion 152 6.6 Conclusion 163 Appendix 164 7 Designofregulatoryinstitutionsindevelopingcountries 171 7.1 Introduction 171 7.2 Lessonsfromhistoryinindustrializedcountries 173 7.3 Organizationtheory 186 7.4 Experiencesinindustrializedcountries 198 7.5 ExperiencesinLatinAmerica 206 7.6 Conclusions 218 8 Separationofregulatorypowersanddevelopment 225 8.1 Introduction 225 8.2 Themodel 227 8.3 Duplicationofinformativesignalsand benevolentregulation 229 Contents vii 8.4 Optimalregulationwithasingleregulator 231 8.5 Optimalregulationwithtworegulators 234 8.6 Separationofpowersindevelopingcountries 237 8.7 Implementingseparationofpowers 238 8.8 Separationofpowersasanendogenousinstitution 240 8.9 Conclusion 242 Appendix 243 9 Concludingremarks 245 9.1 Amoregeneralmodel 245 9.2 Empiricalvalidation 247 9.3 Policyimplications 247 References 249 Index 260 Publisher’s acknowledgment RegulationandDevelopmentwasbeingtypesetatthetimeof Jean-JacquesLaffont’stragicallyearlydeathinMay2004.The Publisher wishes to acknowledge with gratitude the help of Jean-Jacques’ friends and colleagues who, working on both sides of the Atlantic, between them read and corrected the pageproofs:BharatBhole,IsabelleBrocas,AntonioEstache, Hossein Farzin, David Martimort, and Jean Tirole. In their noteattachedtothecorrectedproofstheywrite; Because life did not leave Jean-Jacques time to read the proofs, severalpersonswereinvolvedinreadingandsometimescorrect- ingthem,keepinginmindthedesiretoprovideafinalversion ofthebookascloseaspossibletowhatJean-Jacqueswouldhave likedhimself. We all hope that we have done a good job but are fully con- sciousthatJean-Jacqueswouldhavedonemuchbetterbyhimself. ix