11 - On the Regulation of Investment

Summary

Underinvestment, overinvestment or mistargeted investment are common across sectors at all development stages. They penalize the poorest when it slows down increase in access rates, all users when it leads to congestion, environmental impacts or low quality, and taxpayers as their costs are passed on to final prices or subsidies. These failures are due to poorly designed processes, corruption and capture of politicians or civil servants, and collusion between service providers. Regulation is often part of the problem because cost-plus/rate-of-return regulation tends to stimulate overinvestment, price/revenue cap regulation tends to result in underinvestment, regulated firms can underinvest to exclude potential entrants, regulatory designs omitting to include service obligations and/or access rules lessen incentives to invest, and some regulatory commitments are unrealistic or non-credible. Regulatory failures and uncertainties increase the risk premia built into the financing cost of investment, contributing to further investment mismatch. Regulation can be part of the solution with the adoption of hybrid price regulation approaches and well-designed access prices and rules.