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Better Regulatory Governance
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Water, energy, communications, transport, local utilities — access to these vital services helps determine the quality of life for hundreds of millions of urban and rural people who live in poverty.
These infrastructure services are the “backbone” of both the old and new economies. Efficient infrastructure has powerful upstream and downstream effects throughout the economy, expanding and deepening markets, opening up new opportunities to domestic and foreign investors, and reducing the costs of production and innovation in all sectors.
For these reasons, infrastructure development is central to the ADB’s development and poverty reduction programs. Taxpayers alone cannot cover the huge investments needed to provide accessible, high-quality services.
According to ADB, new infrastructure investment requirements for East Asia were around $1,000 billion in the 1990s. The World Bank estimates that investments of $1,500 billion are needed from 1995 to 2004. These levels cannot be reached without mobilizing private investment and making enterprises in these sectors more efficient and commercially viable through market incentives.
Yet Asian governments are not receiving their global share of private investment, and are starting later than many other developing economies in the competition for private infrastructure capital. To catch up, they must improve regulatory governance and speed up policy reforms.
Levels of private sector participation in Asia’s infrastructure are lower than in Latin America and Europe, and competition is emerging in only a few sectors in a few economies.
Private capital inflows into infrastructure rose from $3 billion in 1990 to $49.8 billion by 1997 in developing countries in East Asia, South Asia, and the Pacific—almost 40% of global private investment in infrastructure in developing countries—according to the World Bank’s Private Participation in Infrastructure database.
But private investment was hit hard by the 1997 Asian financial crisis, falling to $15 billion in 1998. While 1999 and 2000 saw some recovery to $21 billion and $24.7 billion, respectively—27% of global private investment in infrastructure in developing countries—much of this recovery was in the People’s Republic of China (PRC).
Most Asian developing economies continue to suffer from the hangover of the financial crisis, with investment inflows crippled by investor suspicions and doubts. National reputations for good governance are badly damaged.
More important than the financial crisis in slowing private investment is the neglect in Asian countries of the underlying policy and governance reforms seen in Latin America and Europe. Most private investment in those other regions came from divestiture and broad reforms to create competitive markets.
But in Asia, by contrast, most private investment in infrastructure has come from greenfield investment to meet growing demand. Asian state monopolies and interventions are still largely untouched. Investors are lured by concessions, guarantees, and taxpayer-financed contingent liabilities, rather than the chance to innovate and compete fairly for customers.
This pattern, however, is changing.
In 1999, for the first time, revenues from divestitures exceeded greenfield projects in Asia. But policy reforms are still slow, and investors have become wary. To bring them back to Asia, governments must expand market reforms, and work harder and more visibly, to establish a liberal policy environment that sustains market incentives and investor trust.
More flexibility and imagination are needed in fitting regulatory solutions to particular national situations.
For the past decade, regulatory governance has focused on the “independent regulator,” intended to shield market interventions from political and commercial interference and to improve transparency, expertise, stability, and commitment to optimal long-run policy. Asian governments had, by late 2000, created almost 20 independent regulators. More are on the way. This proliferation of independent regulators is fueled by World Trade Organization (WTO) agreements, advice from international institutions, and investor expectations.
Independent regulators are often an improvement compared with regulation by line ministers also responsible for industry promotion and state-owned enterprise operation. Yet independent regulators are no panacea, and cannot substitute for broad policy and governance reforms.
The performance of most regulators in developing economies is disappointing. The difficulties of creating effective regulators are usually underestimated in the face of problems of legitimacy, capture, rigidity, corruption, cost, and fragmented competition policy. A 1998 survey for ADB remarked on “the absence of any well-established independent regulatory agency with a reputation for fair and effective regulation….”
There is no single model for the right regulatory system. The litmus test in attracting private investment is whether the regulatory regime—through sustained commitment to a clear set of rules—is credible to investors, producers, and consumers. Credibility can be built in many ways. Weaker independence of the regulator can, for example, be offset by transparent procedures and stronger judicial review and consumer oversight. In building regulatory credibility, reformers should focus on a few key governance principles.
Commit to ethics. A reputation for honest regulation is the bedrock of credibility. Governments should build strong ethics infrastructures to prevent problems such as conflicts of interest. Revolving doors are particularly damaging, since regulatory leniency is linked to the potential for future employment contracts.
Adopt clear and simple rules for the sector, and enforce them. Policies and standards must be unmistakably clear and fairly implemented. Reducing regulatory risk—the risk that governments will change the rules of the market or will apply rules to benefit national incumbents—is critical in increasing investment inflows, because infrastructure sectors are characterized by long-term commitments, high sunk costs, and intricate property rights. In countries with weak legal traditions, simple rules place fewer demands on courts, are cheaper and more likely to be accurate, and reduce the risk of corruption.
It can be more costly and time-consuming to create new institutions than to agree on clear rules for existing institutions to administer, as Richard Posner at the University of Chicago Law School has noted. The PRC followed the rules-first strategy by introducing modern commercial rules of law when it liberalized its economy. The PRC also moved regulatory powers from line ministries into the State Council, which did not create “independent regulators” but did separate state-owned enterprise management from regulatory decisions, and was welcomed by investors.
Maximize sunshine. Transparency throughout the policy process cures many regulatory failures, such as capture and bias, lack of accountability, inadequate information in the public sector, market uncertainty, and inability to understand policy risk.
Strengthen external checks by consumers, competition authorities, courts, and parliaments. A range of oversight mechanisms—such as the Hong Kong Consumer Council—is another good protection against regulatory capture and abuse. No regulator can be effective alone. The Sri Lankan telecommunications regulator concluded that “one of our biggest achievements was that instead of…appeals going through back channels, we created a situation where an appeal was submitted to the court of appeals.” Checks and balances cannot become paralysis, however, and many countries are working out dispute resolution procedures that can work more efficiently and rapidly.
Staff well. Expert staffing is vital, but a 2000 survey in Southeast Asia found that the new regulatory commissions were not fully staffed and governments had not been able to fill these vacancies. Salary flexibility may be necessary to hire and retain scarce expertise.
The author is managing director of Jacobs and Associates, an international consulting firm on regulatory reform. He may be contacted by sending an e-mail message to scottjacobs@regulatoryreform.com
Viewpoint is a regular feature of ADB Review. Prepared by a senior journalist, academic, or analyst, the articles are meant to provide fresh perspectives and stimulate debate on development issues. The material in this article does not necessarily reflect the official views of ADB.
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