Citation
Mohamedou, E.I. (2014), "Infrastructure regulation in Africa – where do we stand?", African Journal of Economic and Management Studies, Vol. 5 No. 2. https://doi.org/10.1108/AJEMS-01-2013-0005
Publisher
:Emerald Group Publishing Limited
Infrastructure regulation in Africa – where do we stand?
Article Type: Practitioner viewpoint From: African Journal of Economic and Management Studies, Volume 5, Issue 2
1. Introduction
The existing infrastructure stock and services in Africa fall far short of its requirements. Widespread agreement has been reached that private participation is essential to fund the required infrastructure projects providing the critical foundation for sustained development in Africa. But investors will not commit capital if political instability and opportunism make those investments excessively risky relative to expected returns.
Following a strong trend since the mid-1980s for the promotion of private sector participation in the delivery of infrastructure services, African governments have taken upon them to develop regulatory agencies to police the revenues, costs and operations of the privatized utility firms, while at the same time, establishing regulatory credibility among investors and thereby stimulating investment in these sectors and in the economy at large. Privatization was thought to promote more efficient operations, expand service delivery, reduce the financial burden on government and increase the level of foreign and domestic private investment.
On the continent, private participation in infrastructure has been largely concentrated in the telecommunications industry. Energy, which includes electricity and the transmission and distribution of natural gas, attracted the second largest share of investment. In contrast, private participation in the water and sewerage industry has been limited, mostly due to the difficulty of the technology in water provision, the nature of the product, high transaction costs and regulatory weaknesses.
Widened access to affordable utility services remains one of the most important priorities in many African countries. The continent has engaged in several attempts to regulate utilities. This analysis aims at taking stock of the continent’s strides and challenges in the area of infrastructure regulation.
2. What has worked: stocktaking independent regulation
By setting up independent regulatory agencies, governments aim at depoliticizing tariff setting and improving the climate for efficient, low-cost and reliable service provision. Utilities are especially vulnerable to opportunism because the technologies generally require large, sunk investments that are specific to the purpose of providing the utility service, the production methods often have economies of scale and scope, and the services are consumed by large portions of the population. There is substantial empirical evidence, notably from Henisz and Zelner, to support the idea that regulation limits political opportunism. Regulation by independent agencies helps effect a system of checks and balances that limit politicians’ abilities to expropriate at least some of the value of sunk infrastructure investment for short-term political gain.
Independent regulation, which covers such functions as issuing licenses, setting performance standards, approving the level and structure of tariffs, and arbitrating disputes among stakeholders, has been hailed in past years and gained ground on the continent. Most African regulatory agencies are embryonic as they were set up in the late 1990s, early 2000. Most lack funding and qualified personnel. Budgets vary considerably but tend to be modest, ranging from less than $300,000 to about $3,000,000 for electricity. Staffing also varies widely, from one or two people to a couple of dozen. Their mandate is also vague. The concept of “independent” is not clearly defined. Independent from whom? On which aspects? It is usually considered that independence is mostly from the regulated service providers, in particular being separate from them and not accountable to them. The risk seen is that these private sector monopolies will exploit their economic power, leading to a high producer surplus (above normal profits) and a lower consumer surplus (reduced consumer welfare). Consumers could suffer from no – or a limited choice of – goods and services and face monopoly prices. In some difficult governance environments on the continent, this risk carries an even larger weight.
But for others, freedom from interference by the executive arm of the government in the conduct of regulatory affairs is as essential. Also, the risk of a regulator becoming a consumer advocate, in the hope of obtaining popular approval, paying undue attention to consumer demands for lower prices or unreasonably high levels of service is real.
Therefore, a truly independent regulator will function in arms-length relationships with all stakeholders. In this difficult balancing act, decisions should be seen as the result of objective reasoning, not influenced by special considerations being given to any of the parties involved, with decisions taken in accordance with transparent processes and within the context of a clearly defined legal framework. The system of regulatory governance will therefore affect both public perceptions and actual performance of the industry.
An effective independent regulatory agency will signal that it has a governance system that yields credible commitments to stable rules. As compiled by the Australian Competition and Consumer Commission, the features of “best practice” regulation cover:
Accountability: regulators should provide clearly defined processes and rationales for decisions. In addition, appeals procedures need to be specified to provide appropriate checks and balances.
Communication: information should be made available to all stakeholders on a timely and accessible basis.
Consistency: the logic, data sources, and legal basis for decisions should be consistent across market participants and over time.
Consultation: participation of stakeholders in meetings promotes the exchange of information and the education of those affected by regulatory decisions.
Effectiveness and efficiency: cost effectiveness should be emphasized in data collection and in the policies implemented by the regulator.
Flexibility: the agency should use appropriate instruments in response to changing conditions, balancing this regulatory discretion against the costs associated with uncertainty.
Independence: autonomy implies freedom from undue stakeholder influence, which promotes public confidence in the regulatory system.
Predictability: a reputation for predictable decisions facilitates planning by suppliers and customers, and reduces risk as perceived by the investment community.
Transparency: the openness of the process to stakeholders promotes legitimacy.
Short-term focus, often not extending beyond the next election
Deficient policy harmonization due to lack of ministerial cooperation: the role of independent regulators is hindered by the fact that relevant ministries compete instead of communicating, let alone cooperate.
Unpredictability, especially after regime changes – there is a blurring line between regulation and policy-making.
Lack of transparency in decision making.
Limited accountability to stakeholders.
Overburdening bureaucracy.
Capacity constraints of regulators – African countries often lack the necessary trained personnel to sustain regulatory commitment and credibility. Familiarity with the regulatory models and methods of regulatory policy analysis is often limited.
Inconsistent pricing policies, often influenced by political objectives – for example, some governments have sought to improve affordability by imposing cross-subsidies to utility providers, which decreases network expansion by distorting the utilities’ incentives to connect new customers. Once in place, however, cross-subsidies are politically difficult to remove.
Budgetary constraints affecting the quality of decisions – regulators are generally short of resources, usually because of a shortage of government revenue and the high opportunity cost of public funds. Sometimes, funding is deliberately withheld by the government as a means of undermining the agency. A 2002 Africa Forum for Utility Regulation (2002) survey showed that two thirds of surveyed agencies required government approval of their budget.
Information asymmetries, where the regulator and the regulated have different levels of information about such matters as costs, revenues and demand.
“Regulatory capture” by which the regulatory process becomes biased in favour of particular interest groups, notably the regulated companies.
3. Counterfactual: what would have happened in the absence of independent regulation?
Has the chosen model of independent regulation then not been the appropriate one for the African continent? The study “Economic regulation of urban water and sanitation services: some practical lessons” (Water Sector Board Discussion Paper Series, Paper No. 9) published by the World Bank Group queries this choice, and finds more success possibilities with countries where regulatory rules have been embodied in contracts, defining service standards and tariff-setting (or operator remuneration) rules. The study finds that regulatory bodies often equate with political interference which tend to focus on short-term interests and lack coherence, and hence the need to weigh in regulation by contract. However, the latter does present difficulties since “in some circumstances, a contract may not be the best choice. For example, if a given jurisdiction has several regulated water service providers, there may be some advantage in creating a single legal instrument, such as a statute or uniform license, that sets basic rules for all of them”.
Indeed, regulation by contract is not a panacea. There is a higher risk of poor government monitoring of the provider’s performance under a concession contract, undermining customer protection, and thereby reducing the legitimacy of the regulatory system as a whole. Since these contracts are specifically designed to minimize regulatory discretion, they effectively preclude the essential, ongoing involvement of all stakeholders in economic decision making that is at the heart of regulatory development and free-market economic reform. When a regulatory body takes its powers strictly from a contract, the public involvement and public protection functions, which are necessary when the government creates a privately owned or privately operated monopoly service provider, remain often at a ministry or a legislative body. A contract confers rights and obligations on parties to the contract, not third parties and therefore customer protection could be dented. Moreover, in some cases, the inability to change the contract unilaterally may be a disadvantage, resulting in less flexibility and requiring all parties to agree. In an already considered risky investment environment on the continent, this becomes even more of a salient issue.
In addition, it could be argued that the contract model usually puts more emphasis on the bidding process than long-term accountability; and competition is intermittent at best. Contracting is oligopolistic at the bidding stage because few firms qualify as still few companies are willing to invest in the “risky” African continent and become monopolistic once the contract is awarded, with relatively weak competitive pressure over time and a potential for underbidding. Other disadvantages are that special technical processes may “lock in” a contractor with expertise; principal-agent issues and the politicization of decision making remain; and the contract model does not necessarily increase the capacity of local government or that decoupled costs and prices provide no assurance that savings or “profits” will flow into the system improvements or to customers. Furthermore, “foolproof” contracts, crystal-clear performance incentives, and meaningful enforcement mechanisms are required in this model requiring a capacity many African countries lack with typically high costs of renegotiations (some concessions have run into problems, largely because design flaws were left undetected before the contract was awarded). Also, best practices are not necessarily easy to establish as contract terms are not always publicized. Finally, there is little evidence in Africa as to the success of regulation by contract in mobilizing resources, increasing infrastructure investment in system rehabilitation or expansion levels, and reaching higher efficiency targets.
4. End users: have consumers ultimately benefited?
The ultimate objective of utility regulation was to further universal access in Africa in an effort to reduce poverty. And this is one area where independent regulation can be considered to have been successful on the continent. The creation of separate agencies to deal with areas that are seen to be “economically non-viable” such as rural areas has not necessarily led to increase coverage while for instance, in South Africa, through the use of the Regulator, substantial progress has been made towards universal access by the electricity operator, Eskom. In Zambia, the regulation by incentives project administered the water regulator also made strides at advancing access to water using existing operators.
Small private suppliers are also usually in the best position to understand which of the consumer’s requirements can be met and afforded. In addition, a regulator can more easily promote responsible consumer behaviour.
5. Conclusion: success factors
The experience in independent regulation on the continent shows that a strong knowledge of this complex, information-intensive sector (studying foreign experience and debating the merits of various approaches and their applicability) has been key to changes on the ground. Sufficient preparation time and sequencing of reform/events is also essential. Highly skilled and competent human resource capital has also been a success factor. This is particularly essential in terms of results but also to manage the expectations of the populations in terms of service delivery as well as sustainability of the government’s engagement. In this regard, consensus building has been crucial: where processes, such as in Zambia, of consumer advocacy groups, stakeholder meetings, and dealing with incumbent workers have received adequate attention, results have been sustained. Finally, as in many other development issues, the commitment of the state and its executive to provide strong regulatory institutions that can act independently and forcefully is critical[1].
Among the challenges confronting the utility regulation sector in the future, however, is the policy dilemma about how to fund capital investment without high tariffs restricting expanding access. Efforts in African countries currently emphasize tariff rationalization. Much still needs to be investigated and proposed as to how to reduce unit costs in the sector, make tariffs affordable and improve the sustainability of cost-recovery efforts. The challenge of improving governance remains and lies at the intersection of politics and administration that utility regulation puts upfront. Pragmatically, indigenous solutions of interdependence rather than independence will need to be developed. And in this endeavour, capacity building and institutional strengthening for robust and independent regulation in African countries will need to be further supported.
Realistic and appropriate benchmarking is also needed to strengthen the sector on the continent. A balanced scorecard approach must recognize regional variations, taking into account for instance higher construction costs in some countries. The process of engagement with stakeholders will also need to gain further relevance, in particular in the case of IPPs.
In general, it seems many critics make the irrational demand that regulators on average ageing less than 15 years in Africa behave at all times with a skill and foresight expected of regulators over a 100 years old in other parts of the world. This is a fallacy we need to avoid and give time to a long learning process and evolving industry.
El Iza Mohamedou
African Development Bank, Tunis, Tunisia
Note
1. This is building in particular on the insights of the new institutional economics which argue that economic development is not simply the result of amassing economic resources in the form of physical and human capital, but is also a matter of “institutional building” that reduces information imperfections, maximizes economic incentives and reduces transaction costs.
Further reading
Acemoglu, D. and James, A.R. (2006), Persistence of Power, Elites and Institutions, Centre for Economic Policy Research, London.
Armstrong, M., Cowan, S. and Vickers, J. (1994), Regulatory Reform: Economic Analysis and British Experience, MIT Press, Cambridge, MA.
Berg, S.V. (2001), “Infrastructure regulation: risk, return, and performance”, Global Utilities, Vol. 1, pp. 3-10.
Bromley, D.W. (1989), Economic Interests and Institutions: The Conceptual Foundations of Public Policy, Basil Blackwell, Oxford.
Guasch, J.L. and Hahn, R.W. (1999), “The costs and benefits of regulation: implications for developing countries”, The World Bank Research Observer, Vol. 14 No. 1, pp. 137-158.
Henisz, W.J. and Zelner, B.A. (2001), “The institutional environment for telecommunications investment”, Journal of Economics and Management Strategy, Vol. 10 No. 1, pp. 123-147.
International Finance Corporation (IFC) (2002), “Trends in private investment in developing countries, 1970-2000”, Discussion Paper No. 44, World Bank, Washington, DC.
Kirkpatrick, C., Parker, D. and Yin-Fang, Z. (2006), “Foreign direct investment in infrastructure in developing countries: does regulation make a difference”, Transnational Corporations, Vol. 15 No. 1, pp. 155-166.
North, Douglass Cecil (1990), Institutions, Institutional Change and Economic Performance, Cambridge University Press, Cambridge.
World Bank (1995), Bureaucrats in Business: The Economics and Politics of Government Ownership, Oxford University Press and World Bank, Oxford and Washington, DC.
About the author
Dr El Iza Mohamedou was Chief Regional Integration and Trade Officer at the African Development Bank (ADB). She was previously Programme Manager at the African Forum for Utility Regulators. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author and do not necessarily represent the view of the any institution. Dr El Iza Mohamedou can be contacted at: mailto:zaza_mohamedou@yahoo.com