Water

Regulation: What Works, Where, and Why?¹
Lessons from Case Studies on Water Supply and Sanitation Regulators
(May 2006)

Much has been written about the theory and application of regulation, but little is understood about how regulatory systems really work in developing countries. A study of four case studies reveal some interesting lessons-or themes-about what makes regulation work in different country settings.

What makes regulation work in different countries? This was the subject of a recent World Bank research program, which focused on four country experiences:

• Port Vila, Vanuatu—A town of 40,000 where a piped water supply is provided by the private firm UNELCO under a concession contract. The Government is responsible for monitoring the contract

• Manila, the Philippines—Piped water supply for the 10 million inhabitants is provided by two private water companies under concession agreements. The agreements are regulated by the MWSS Regulatory Office, a quasi-independent body

• Senegal—A private firm provides water services to the country of 11 million people under a 10-year affermage (lease) contract. The contract is monitored by various organizations

• Bogota, Colombia—A government-owned water company provides service to the city's 7 million people. Tariff setting rules are set by the CRA, the national water regulatory body, and enforced by a separate entity

The study revealed key lessons or themes that challenge some of the conventional theory on what makes regulation work. It also sets out some ideas for what is most important to consider when designing a new or improved regulatory system for a country's water sector.

Top

Conventional theory suggests that an independent regulator is necessary for 'good regulation'. In some countries, this approach can work. But, in the water sector many governments have engaged the private sector to operate water systems under contractual arrangements (such as a lease or concession). In these cases, governments may opt for regulation by contract. The case studies show that regulation by contract can work well, and often does work just as well—if not better—than regulation by organization. For example, in Vanuatu, UNELCO has met its service standards, customers are happy with the service, and there have not been any disputes.

In contrast, both Manila and Bogota have (partially) independent regulatory organizations, but neither case demonstrated better regulatory results than achieved with regulation by contract. This suggests that an independent regulatory organization, on its own, is not a key determinant for successful regulation.

Top

While regulation by contract can be effective, good supporting organizations are needed.

In Senegal, for example, there was a dedicated contract monitoring unit, the Government was actively involved in its relationship with the utility, and outside expert advice was brought in to help resolve disputes. Also, because contracts can be incomplete and discretion is required to apply regulation, it is important to have institutions that can step in to resolve disputes (such as external mediators, arbitrators, and experts tasked with giving independent opinions on disputed matters).

It is also important to ensure that organizational mandates and contractual provisions are correctly aligned. Manila is a case in point. The Regulatory Office is loosely modeled on Ofwat (the water regulator for England), but because the Regulatory Office has to function within the context of concession contracts, there has sometimes been confusion over its role. Disagreement over this regulatory role has led to very public battles between stakeholders, and damaged the credibility of the Regulatory Office.

Top

Good regulation has traditionally been defined as independent, and conducted at an arm's length from Government officials. Given that water tariffs and service standards are such socially sensitive issues, however, political intervention may be inevitable, especially if a regulatory decision is unpopular. In all four case studies, the political head of the country became involved at some point in setting the tariffs-even when the regulatory system was designed to keep politics out.

It may be better to 'design in' politics in areas of regulation that involve policy-related decisions. For example, in Senegal the Government is explicitly involved: the Government sets consumer tariffs, but must guarantee payments to the provider. In this example, it shows that it bears the fiscal risk of making a social decision to set tariffs below cost-recovery levels.

Top

Care is required to 'fit' the regulatory organizations and arrangements into a country's existing institutional, political and legal structure. Community size and relationships are important. Port Vila in Vanuatu is a small community, so utility managers have closer ties to the communities they live and serve in, and have added incentive to provide a good level of service. This 'informal' channel of accountability may not be as apparent in large city environments.

Familiar systems of 'control' also produce more reliable results. Whether regulation is better undertaken through a contract or through a regulatory organization is influenced by the administrative, legal, and judicial systems. Countries with influence from the French legal system tend to work better with a contract, whereas systems influenced more by the Anglo-Saxon legal tradition may fare better with a regulatory organization. What is clear is that when the two systems are juxtaposed, as in Manila, the regulatory role and decision-making powers can become confused, damaging regulatory credibility and predictability.

Top

In addition to the key themes discussed previously, the study also yielded some additional insights.

Detailed guidelines help—An important challenge for any regulatory system is deciding how detailed the 'rules' should be. The cases showed that poor definitions in the regulatory rules can lead to ambiguous relationships and processes. But while clear rules are important, if they are too complex and onerous, they can impede the regulatory process. Regulators should strive for rules that are simple, predictable, and easy to understand and follow.

Donors sometimes have a role to play—Donors often offer support to develop regulatory systems and engage the private sector to provide water services. But they typically seek not to 'interfere' in the regulatory process once the contract is underway. However, under certain conditions, donor advisors, without local biases, can provide external expertise that can help increase the chance of regulatory success.

Individuals matter—Designers of regulatory systems generally focus on the importance of organizational structures and functions. Unsurprisingly, the case studies show that individuals matter. The qualities and skills of the individuals tasked with regulation significantly influenced the success of the regulatory arrangements.

Top

The most important theme that emerged from the case study is that there is no international best practice for regulation. There is no 'best' regulatory model that can be applied everywhere. The focus of regulatory design, therefore, should not be to follow a fixed formula, but to strive to achieve the 'ideal attributes' of coherence, credibility, predictability, legitimacy, transparency, and accountability. In achieving these attributes, a country's local culture, economy, and political environment should be recognized. This requires care in the design and sustained support to build regulatory experience and credibility.

Top

The case studies were prepared by Castalia (www.castalia.fr) under a World Bank research program on effective regulation. Castalia is a consulting firm specializing in regulation and private sector participation in the water and electricity sectors.

___________________________