OECD Economics Department Working Papers
Working papers from the Economics Department of the OECD that cover the full range of the Department’s work including the economic situation, policy analysis and projections; fiscal policy, public expenditure and taxation; and structural issues including ageing, growth and productivity, migration, environment, human capital, housing, trade and investment, labour markets, regulatory reform, competition, health, and other issues.
The views expressed in these papers are those of the author(s) and do not necessarily reflect those of the OECD or of the governments of its member countries.
- ISSN: 18151973 (online)
- https://doi.org/10.1787/18151973
Infrastructure Investment in Network industries
The Role of Incentive Regulation and Regulatory Independence
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.
Keywords: rate-of-return regulation, regulatory independence, incentive regulation, price cap, investment, cost-plus regulation, network industries
JEL:
L98: Industrial Organization / Industry Studies: Transportation and Utilities / Industry Studies: Utilities and Transportation: Government Policy;
L97: Industrial Organization / Industry Studies: Transportation and Utilities / Utilities: General;
L51: Industrial Organization / Regulation and Industrial Policy / Economics of Regulation
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